For quite some time, I have been making this point here about China having some seriously weak links in the chain of the story of how it is going to take over the world such as its inverted demographic profile, seriously dishonest bookkeeping, and the fact that it is a worsening toxic dump.

I agree 100%. If China challenges us to be the number one economy in the world in our lifetime under their current regime, it can only be because of catastrophic policy failure in the U.S.

Current Pulitzer Prize winner WSJ/Brret Stephens:Reading Hayek in Beijing May 24, 2013A chronicler of Mao's depredations finds much to worry about in modern China.

Yang Jisheng By BRET STEPHENS

In the spring of 1959, Yang Jisheng, then an 18-year-old scholarship student at a boarding school in China's Hubei Province, got an unexpected visit from a childhood friend. "Your father is starving to death!" the friend told him. "Hurry back, and take some rice if you can."

Granted leave from his school, Mr. Yang rushed to his family farm. "The elm tree in front of our house had been reduced to a barkless trunk," he recalled, "and even its roots had been dug up." Entering his home, he found his father "half-reclined on his bed, his eyes sunken and lifeless, his face gaunt, the skin creased and flaccid . . . I was shocked with the realization that the term skin and bones referred to something so horrible and cruel."

Mr. Yang's father would die within three days. Yet it would take years before Mr. Yang learned that what happened to his father was not an isolated incident. He was one of the 36 million Chinese who succumbed to famine between 1958 and 1962.

It would take years more for him to realize that the source of all the suffering was not nature: There were no major droughts or floods in China in the famine years. Rather, the cause was man, and one man in particular: Mao Zedong, the Great Helmsman, whose visage still stares down on Beijing's Tiananmen Square from atop the gates of the Forbidden City.

Enlarge ImageimageimageZina Saunders

Yang Jisheng

Mr. Yang went on to make his career, first as a journalist and senior editor with the Xinhua News Agency, then as a historian whose unflinching scholarship has brought him into increasing conflict with the Communist Party—of which he nonetheless remains a member. Now 72 and a resident of Beijing, he's in New York this month to receive the Manhattan Institute's Hayek Prize for "Tombstone," his painstakingly researched, definitive history of the famine. On a visit to the Journal's headquarters, his affinity for the prize's namesake becomes clear.

"This book had a huge impact on me," he says, holding up his dog-eared Chinese translation of Friedrich Hayek's "The Road to Serfdom." Hayek's book, he explains, was originally translated into Chinese in 1962 as "an 'internal reference' for top leaders," meaning it was forbidden fruit to everyone else. Only in 1997 was a redacted translation made publicly available, complete with an editor's preface denouncing Hayek as "not in line with the facts," and "conceptually mixed up."

Mr. Yang quickly saw that in Hayek's warnings about the dangers of economic centralization lay both the ultimate explanation for the tragedies of his youth—and the predicaments of China's present. "In a country where the sole employer is the state," Hayek had observed, "opposition means death by slow starvation."

So it was in 1958 as Mao initiated his Great Leap Forward, demanding huge increases in grain and steel production. Peasants were forced to work intolerable hours to meet impossible grain quotas, often employing disastrous agricultural methods inspired by the quack Soviet agronomist Trofim Lysenko. The grain that was produced was shipped to the cities, and even exported abroad, with no allowances made to feed the peasants adequately. Starving peasants were prevented from fleeing their districts to find food. Cannibalism, including parents eating their own children, became commonplace.

"Mao's powers expanded from the people's minds to their stomachs," Mr. Yang says. "Whatever the Chinese people's brains were thinking and what their stomachs were receiving were all under the control of Mao. . . . His powers extended to every inch of the field, and every factory, every workroom of a factory, every family in China."

All the while, sympathetic Western journalists—America's Edgar Snow and Britain's Felix Greene in particular—were invited on carefully orchestrated tours so they could "refute" rumors of mass starvation. To this day, few people realize that Mao's forced famine was the single greatest atrocity of the 20th century, exceeding by orders of magnitude the Rwandan genocide, the Cambodian Killing Fields and the Holocaust.

The power of Mr. Yang's book lies in its hauntingly precise descriptions of the cruelty of party officials, the suffering of the peasants, the pervasive dread of being called "a right deviationist" for telling the truth that quotas weren't being met and that millions were being starved to death, and the toadyism of Mao lieutenants.

Yet the book is more than a history of a uniquely cruel regime at a receding moment in time. It is also a warning of what lies at the end of the road for nations that substitute individualism with any form of collectivism, no matter what the motives. Which brings Mr. Yang to the present day.

"China's economy is not what [Party leaders] claim as the 'socialist-market economy,' " he says. "It's a 'power-market' economy."

What does that mean?

"It means the market is controlled by the power. . . . For example, the land: Any permit to enter any sector, to do any business has to be approved by the government. Even local government, down to the county level. So every county operates like an enterprise, a company. The party secretary of the county is the CEO, the president."

Put another way, the conventional notion that the modern Chinese system combines political authoritarianism with economic liberalism is mistaken: A more accurate description of the recipe is dictatorship and cronyism, with the results showing up in rampant corruption, environmental degradation and wide inequalities between the politically well-connected and everyone else. "There are two major forms of hatred" in China today, Mr. Yang explains. "Hatred toward the rich; hatred toward the powerful, the officials." As often as not they are one and the same.

Yet isn't China a vastly freer place than it was in the days of Mr. Yang's youth? He allows that the party's top priority in the post-Mao era has been to improve the lot of the peasantry, "to deal with how to fill the stomach."

He also acknowledges that there's more intellectual freedom. "I would have been executed if I had this book published 40 years ago," he notes. "I would have been imprisoned if this book was out 30 years ago. Now the result is that I'm not allowed to get any articles published in the mainstream media." The Chinese-language version of "Tombstone" was published in Hong Kong but is banned on the mainland.

There is, of course, a rational reason why the regime tolerates Mr. Yang. To survive, the regime needs to censor vast amounts of information—what Mr. Yang calls "the ruling technique" of Chinese leaders across the centuries. Yet censorship isn't enough: It also needs a certain number of people who understand the full truth about the Maoist system so that the party will never repeat its mistakes, even as it keeps the cult of Mao alive in order to preserve its political legitimacy. That's especially true today as China is being swept by a wave of Maoist nostalgia among people who, Mr. Yang says, "abstract Mao as this symbol of social justice," and then use that abstraction to criticize the current regime.

"Ten million workers get laid off in the state-owned enterprise reforms," he explains. "So many people are dissatisfied with the reforms. Then they become nostalgic and think the Mao era was much better. Because they never experienced the Mao era!" One of the leaders of that revival, incidentally, was Bo Xilai, the powerful former Chongqing party chief, brought down in a murder scandal last year.

But there's a more sinister reason why Mr. Yang is tolerated. Put simply, the regime needs some people to have a degree of intellectual freedom, in order to more perfectly maintain its dictatorship over everyone else.

"Once I gave a lecture to leaders at a government bureau," Mr. Yang recalls. "I told them it's a dangerous job, you guys, being officials, because you have too much power. I said you guys have to be careful because those who want approval from you to get certain land and projects, who bribe you, these are like bullets, ammunition, coated in sugar, to fire at you. So today you may be a top official, tomorrow you may be a prisoner."

How did the officials react to that one?

"They said, 'Professor Yang, what you said, we should pay attention.' "

So they should. As Hayek wrote in his famous essay on "The Use of Knowledge in a Society," the fundamental problem of any planned system is that "knowledge of circumstances of which we must make use never exists in concentrated or integrated form but solely as the dispersed bits of incomplete and frequently contradictory knowledge which all the separate individuals possess."

The Great Leap Forward was an extreme example of what happens when a coercive state, operating on the conceit of perfect knowledge, attempts to achieve some end. Even today the regime seems to think it's possible to know everything—one reason they devote so many resources to monitoring domestic websites and hacking into the servers of Western companies. But the problem of incomplete knowledge can't be solved in an authoritarian system that refuses to cede power to the separate people who possess that knowledge.

"For the last 20 years, the Chinese government has been saying they have to change the growth mode of the economy," Mr. Yang notes. "So they've been saying, rather than just merely expanding the economy they should do internal changes, meaning more value-added services and high tech. They've been shouting such slogans for 20 years, and not many results. Why haven't we seen many changes? Because it's the problem that lies in the very system, because it's a power-market economy. . . . If the politics isn't changed, the growth mode cannot be changed."

That suggests China will never become a mature power until it becomes a democratic one. As to whether that will happen anytime soon, Mr. Yang seems doubtful: The one opinion widely shared by rulers and ruled alike in China is that without the Communist Party's leadership, "China will be thrown into chaos."

Still, Mr. Yang hardly seems to have given up hope that he can play a role in raising his country's prospects. In particular, he's keen to reclaim two ideas at risk of being lost in today's China.

The first is the meaning of rights. A saying attributed to the philosopher Lao Tzu, he says, has it that a ruler should fill the people's stomachs and empty their heads. The gambit of China's current rulers is that they can stay in power forever by applying that maxim. Mr. Yang hopes they're wrong.

"People have more needs than just eating!" he insists. "In China, human rights means the right to survive, and I argue with these people. This is not human rights, it's animal rights. People have all sorts of needs. Spiritual needs, the need to be free, the freedoms."

The second is the obligation of memory. China today is a country galloping into a century many people believe it will define, one way or the other. Yet the past, Mr. Yang insists, also has its claims.

"If a people cannot face their history, these people won't have a future. That was one of the purposes for me to write this book. I wrote a lot of hard facts, tragedies. I wanted people to learn a lesson, so we can be far away from the darkness, far away from tragedies, and won't repeat them."

China must be prepared for capital exit2013-05-27 By Hong Liang China Daily

At the G20 meeting in Washington last month, the International Monetary Fund sounded a warning about the problems that could be caused by a sudden massive outflow of capital from emerging markets when the major developed economies, notably the United States, terminate their quantitative easing programs.

Since the US Federal Reserve started its quantitative easing program some two years ago, there has been a large flow of capital into emerging markets in search of higher returns. This flood of money has, in turn, inflated asset prices in these markets and pushed up the value of their respective currencies.

These aggressive monetary policies adopted by some developed economies to stimulate their economic growth cannot be sustained for too long as they can create their own problems with too much cheap money floating around. It's widely expected that governments will stop printing money as soon as their economies show definite signs of a sustainable recovery.

That may come sooner than expected, and a more optimistic economic outlook in developed countries could trigger a reversal in capital flows out of emerging markets. A sudden capital outflow could burst the asset bubbles in some emerging markets, sparking a financial crisis as many enterprises have greatly increased their foreign currency borrowings at low interest rates to fund their domestic investments.

Acknowledging the "crucial" role of "accommodative monetary policy" in stimulating economic growth, the IMF cautioned in a statement issued at the conference that there is a need to monitor the potential impacts of monetary easing on capital flows and exchange rates. "Eventual exit from monetary expansion will need to be carefully managed and clearly communicated," the statement said.

At the conference, IMF Managing Director Christine Lagarde warned that "unconventional" monetary policy has raised international concern about currency valuations and competitive depreciation. She added that the IMF will probe further into the consequences of unconventional monetary policy and "what will be the consequences of the variety of exit and what will be good exits as opposed to the more unpleasant exits" for all IMF member countries.

At that time, the US economy was still mired in a sputtering recovery hamstrung by persistently high unemployment and tepid consumer demand. In Japan, the monetary easing program, though large in scale, was too new to have produced any results, although some neighboring economies were already seeing a marked increase in the influx of capital. Under these circumstances, the IMF warnings about exit policy seemed premature and economic planners in most countries didn't take them seriously.

Not anymore. The marked improvement in the US' employment figures has raised expectations that the Fed will consider moderating the pace of its monthly bond purchases. The Fed is schedule to debate policy on June 18 and 19.

With a balance sheet swollen to some $3.3 trillion, the Fed must weigh the risks of igniting future inflation or blowing up asset bubbles against printing more money to pump up the economy. Fed Chairman Ben Bernanke and other Fed officials have said that any reduction in bond purchases would not indicate a withdrawal of monetary stimulus. But to many emerging market observers, preparation by the Fed for an exit is on the way.

In a recent speech, the text of which was published last week, Liu Yuhui, a financial researcher at the Chinese Academy of Social Sciences, said that the normalization of US monetary policy is expected to rapidly gather pace, causing a severe contraction in the international flow of the US dollar, which would, in turn, exert tremendous pressure on asset markets across the Asia-Pacific region.

Liu said that Chinese banks need to strengthen their financial structures to face the threats coming from abroad, warning that assets, mainly properties, were already valued at levels considered too high.

"China facing a bubble? Who knew?"Ummm , , , as posted here for a few years now, I did though not for the reasons here based upon Keynesian drivel , , ,

Yes, I agree on the first part. On the second point I'm not sure if I follow you. When QE ends, some of the artificial effects of it end with it, with consequences. I am all for QE ending, just saying what seems to be widely ignored, it won't be pretty if and when it happens. This was one of 3 posts on 3 separate threads but taken together, if they each have validity, the slightly negative economic news coming out of India, Korea and China, (and Japan and elsewhere) poses risks for global companies and investors everywhere.

Will their bubble pop before ours does? They have a few advantages over us, such as a leadership that knows that marxism doesn't work.....

Good point. My point is not which goes first but of the interconnectedness. Either burst would have a major, adverse effect on the other. To take one local Dow listed example, how does 3M's sales performance and outlook look without rapidly growing Asia sales and operations? Not nearly as good as it does now.

"When QE ends, some of the artificial effects of it end with it, with consequences. I am all for QE ending, just saying what seems to be widely ignored, it won't be pretty if and when it happens."

Maybe QE-X has been a BAD thing, i.e. holding the economy back? Maybe it has been as Scott Grannis has said, simply ineffective because money growth has been constant and the QE simply showing up in bank reserves, not money supply?

A cash crunch over the past three weeks has caused rates on loans between banks to spike to the highest levels since mid-2011, drawing attention back to China's financial instability. Rates have since subsided, but conditions exist for them to remain elevated over the next month or beyond. Unlike two years ago, at least one bank has already defaulted on a loan and there are rumors that other defaults have occurred. The emergence of bank defaults poses a serious challenge to the central government's efforts to clamp down on credit growth as part of its broader attempt to reform the country's economy.Analysis

The recent spike in interbank lending rates began in late May after a combination of factors caused a liquidity shortage. The monthly average overnight rate stood at 2.9 percent for April but rose to 6.4 percent for May. In particular, companies sought to pay taxes at the end of May and banks rushed to meet regulators' reserve requirements, leaving them with less cash on hand. Meanwhile, the lead-up to the Dragon Boat Festival, a national holiday that closed markets from June 10-12, spurred consumers to withdraw deposits, further squeezing banks.Shanghai Interbank Offered Rate, Monthly Average

In addition to these seasonal factors, the central government's attempts to rein in the high rate of credit expansion also contributed. In February, the People's Bank of China started reducing liquidity injections, and as rates rose in early June it mostly refrained from softening this stance. Meanwhile, in early May, the State Administration of Foreign Exchange issued new measures against falsifying trade data in order to import funds illegally, a move that brought down reported export volumes and foreign exchange inflows.Shanghai Interbank Offered Rate, Daily Average

A similar confluence of factors led to a spike in interbank rates during roughly the same period in 2011. But this time around the consequences have raised greater fears. On June 6, China Everbright Bank, the country's 11th-largest lender, defaulted on a 6 billion-yuan ($980 million) loan repayment to Industrial Bank Co. The default allegedly caused Industrial Bank Co. to default in turn, and various news reports have suggested that other banks also may have defaulted on loans, though this is unconfirmed. On June 7, the central bank allowed more cash to flow into the interbank market as previously scheduled, providing some relief for strained banks, though it did not take any additional actions. The cash crunch manifested elsewhere when the Ministry of Finance and state-owned Agricultural Development Bank failed to sell all the bonds offered in recent auctions, occurrences that, though not unprecedented, are rare and reflect the liquidity shortage. The Agricultural Development Bank has scaled back upcoming bond sales as a result.

These recent events point to the rising financial trouble in China, where debt levels have rapidly grown as a result of the investment-driven economic model and the post-financial crisis drop in export growth. Bank failures are rare in China, where state entities step in quietly to prevent panic and ensure stability. For examples one must look to the last banking crisis in the late 1990s, though the failure of a rural credit cooperative in Jiangsu in 2012 points to the recent rise in risk. Recently, for instance, China Securities Journal claimed that the total credit in China's system may add up to 221 percent of gross domestic product, far above officially reported figures.

The size and rapid growth of China's credit expansion is coupled with the murkiness of the details about the lending -- the well-documented explosion in shadow banking and the huge growth in financial instruments such as wealth management products that deliver high returns but that regulators say are based on unclear or illiquid assets. Financial analysts have recently raised alarms about the dangers of this informal lending spree -- Fitch Ratings, Societe Generale and others, including Stratfor sources, have all warned of these recent signs that the debt buildup may finally have reached a point at which growth rates cannot sustain it. The Chinese central government's attempts to clamp down on lending channels reveal it is aware of the risks.

It is too early to tell whether the latest cash crunch is the harbinger of an immediate descent into financial turmoil. First, at the moment there does not appear to be contagion from the Everbright default or other rumored defaults. Second, the fact that the recent liquidity shortages resulted from central government tightening policies suggests that easing those policies can alleviate the problem for a time. The central bank has large reserves with which to fight fires (about $3.44 trillion in foreign exchange reserves), though clearly it fears that the speed, size and opaqueness of recent years' credit expansion could lead to an unmanageable chain reaction. Third, Everbright itself is a chronically troubled bank -- one that received a bailout as recently as 2007 and is mostly owned by an arm of the Ministry of Finance, Central Huijin, which is increasing its stake -- and therefore its default does not seem to have created the kind of shock that the default of a supposedly healthy bank would have done. Nevertheless, its failure to repay is just the beginning -- there are numerous other small- and medium-sized banks that are more highly leveraged than Everbright and more heavily exposed to innovative products with unknown risks.

The cash squeeze is expected to continue at least through June and July as a result of accounting practices at the end of the first half of the year and expectations that the central government will maintain tight policies on credit, not to mention other factors that could encourage capital outflows, such as the U.S. Federal Reserve reportedly considering halting its quantitative easing policies. Given the underlying factors of high leverage, slowing growth and tight government policy in a new administration that must prove its resolve in executing tough reforms, the conditions are ripe for further troubles among poorly managed banks.

At the moment, China's cash crunch resembles that of 2011 and seems mostly policy-driven. But the situation merits close attention. Stratfor has long called attention to the hidden debt eating away at the core of China's economic model, the debt surge after the global financial crisis and the constraints on Beijing's attempts to transition to something more sustainable. If more bank defaults occur and the central bank refuses to provide support, or if the central bank eases policy and bank troubles continue unabated, then authorities could soon find themselves overwhelmed. China's poor financial fundamentals point to increasing turmoil sooner or later.

Agree. Rapid growth covered up a multitude of sins. A slowing of growth exposes weaknesses. There will be an economic reckoning. Oddly, if Europe and the US (China's biggest customers) could get their own economic acts together, that would help China stay on track.

I don't think the political apparatus of China can withstand an economic meltdown. Or as Wesbury might call it when 50% of loans fail, workhorse banking?

Over the past two weeks China's interbank lending rates have spiked, bond auctions have failed and one large bank briefly defaulted. The Shanghai stock market fell 5.3% Monday, on top of big losses last week. This is all evidence that China's leaders have decided to call time on one of the greatest credit expansions in history.

Shortages of liquidity are not unusual in China, especially before the end of a quarter when the banks shuffle assets to meet limits on loan-to-deposit ratios. Usually the central bank steps in with some loans and the pain goes away.

This time, however, the People's Bank of China has largely remained on the sidelines and the pain has persisted. A PBOC statement Monday reiterated that banks must reduce risky loans and avoid short-term liabilities to finance long-term assets. Last Thursday, the State Council emphasized the need to contain financial risks and prepare for interest-rate liberalization.

That's great news for China's long-term economic prospects, but there will be widespread pain as banks scale back lending. The worry is that Beijing waited too long and a large number of unviable companies will need to be restructured. Growth would then slow substantially and the banking system could need recapitalization.

Beijing has the means to bail out the banks, but it's critical that the banking system is reformed so any bailout is truly the "last supper." That was the phrase then PBOC Governor Dai Xianglong used to describe capital injections in 2000. Three years later, the bankers were back at the trough.

After the 2003 episode, reforms made us cautiously optimistic that the four huge state-owned banks would operate as commercial entities rather than agents of the government. They modernized their systems and managed to list their shares. But with interest rates still held artificially below the rate of inflation, the seeds of another crisis were sown in the mid-2000s, as a shadow banking system emerged. According to Standard & Poor's, shadow lending has grown at 34% for the last couple of years, so that by the end of 2012 its assets were equivalent to 34% of outstanding bank loans and 44% of GDP.

This is not all bad, as trust companies, credit guarantee firms and other dodges allowed private companies to get access to credit at higher rates. But it has contributed to a massive expansion of corporate debt. According to Fitch, loans from banks and shadow banking institutions totaled 198% of GDP in 2012, up from 125% in 2008.

The real economy has slowed despite continuing double-digit credit growth, with some projections that China might miss this year's government GDP target of 7.5%. This has sent a clear message to China's leaders that credit-driven growth is a dead end. They are evidently serious that future growth will have to be driven by reform, starting with market-based interest rates.

If a reckoning for wasteful lending does come, there will inevitably be political implications. Some observers have attributed new leader Xi Jinping's emphasis on nationalism as preparation for this economic adjustment. Despite the short-term pain, a more market-oriented economy will be more prosperous and fair, and will also better provide public goods like clean air and safe food.===========================

Summary

Spiking interbank lending rates may be only a temporary flare up, but they reveal the depth of China's banking troubles. Over the past year, the economic slowdown has caused some of the country's massive shadow lending to unravel. If financial instability continues, it will complicate President Xi Jinping and Premier Li Keqiang's attempts to engineer a stable economic slowdown for the purposes of reform and rebalancing.Analysis

The People's Bank of China released a statement June 24, though it was dated June 17, addressing the liquidity shortage that caused interbank lending rates to spike during most of June. The central bank claimed that the banking system's general liquidity level remained "reasonable" but that changes in financial markets and the need to tidy up books at the end of the first half of the year led to higher requirements, causing the liquidity squeeze. The statement went on to warn commercial banks to better prepare to meet tax payments and reserve requirements. It also warned them to manage credit expansion at a time when the government intends to maintain "prudent" monetary policy and "steady and moderate" monetary and credit growth. Last, it warned against letting deposits fall too low.

The central bank has been heavily scrutinized amid the recent disturbances in interbank markets because the banks, as well as many investors and commentators, have called attention to its hesitancy to inject liquidity into the system to reduce the shortages. When the central bank finally took action last week by acting as lender of last resort past normal working hours and by providing special loans to particularly troubled lenders, interbank rates subsided from last week's record highs. The June 24 statement will reinforce the view that policy will remain tight and interbank rates elevated, but that banks will calm down somewhat in July as the scramble to meet half-year deadlines ends and as a number of central bank bills mature, sending cash back into the system. The People's Bank also says it will play a "stabilizing" role.Shanghai Interbank Offered Rate, Daily Average - June 24

But even if interbank rates fall during and after July, the showdown between the central bank and the rest of the banking system points to bigger risks and challenges. Rumors surfaced in the Chinese media last week that the central bank provided emergency assistance worth "less than" 400 billion yuan (about $65 billion) to two of the Big Four state-owned commercial banks: Bank of China and Industrial and Commercial Bank of China. If accurate, these rumors show that the cash shortage is by no means limited to medium-sized lenders like Everbright Bank, whose Shanghai branch defaulted on a 6 billion yuan loan June 6. The Big Four form the backbone of China's financial system. A bailout for two of them illustrates the central bank's willingness and ability to intervene to prevent widespread contagion. However, it also suggests that the entire system is severely strained.

Moreover, focusing on matters within the central bank's control, such as liquidity injection, directs attention away from smaller signs across the country over the past year that businesses in various sectors, along with the shadow loans tied to investment projects, have been failing:

October 2012: Jiayue Co., a leading real estate company in Zhanjiang, Guangdong province, and dozens of connected firms went bankrupt, leaving about 6.1 billion yuan in debts unpaid. October 2012: Chenyang Rural Credit Cooperative in Sheyang County, Jiangsu province, suffered a rush on deposits after a credit guarantee company was shut down for illegal lending. The Sheyang County government forced the company to sell 25 million yuan in assets to pay depositors. December 2012: Citic Trust Co., an division of China Citic Group, delayed payment on one of its trust products after a steelmaker, Three Gorges Quantong, missed a 74.6 million yuan payment. Eventually the city government in Yichang, Hubei province, paid 1 billion yuan to support Quantong, which is now said to owe 7 billion yuan to several banks because of a failed wealth management product. January 2013: Huaxia Bank in Shanghai failed to make an interest payment on a 140 million yuan wealth management product, according to a high-profile report by Caixin. The chief borrower collapsed after embezzling the funds lent, but the company that guaranteed the product, Zhongfa Investment Guarantee, paid back investors. Various other defaults on loans or wealth management products have occurred. Jilin Trust defaulted on a 150 million yuan trust product, as did unnamed companies in Ordos, Inner Mongolia, where excessive housing construction has led to overcapacity. China Communication Bank also saw the failure of a wealth management product. Reports in Chinese media suggest that privileged state-owned enterprises have increasingly begun defaulting on payments owed to small- and medium-sized companies, which have little recourse.

From these incidents -- and several other rumored events, including the most recent troubles among large banks -- it appears that the rapid and vast expansion of shadow lending is unraveling, at least to some extent, under the pressure of China's economic slowdown and rebalancing reforms. The highest risk areas are joint-stock banks and other banks most exposed to wealth management products (13 trillion yuan total) and trust products (more than 5 trillion yuan total), plus the credit guarantee companies and banks that remain liable when such products fail and the hierarchy of local governments that are forced to bail out failed companies and banks. Ultimately, these risks even threaten the central government, since large banks can be affected and local governments themselves, which are often struggling with debt levels well above 100 percent of revenues, may prove incapable of handling local crises.

The central government has extensive resources and plenty of room to lower reserve requirements or take other actions to ease policy. It could moderate its recent attempts to crack down on high-risk financial products and illegal capital inflows, though it will not want to backtrack unless circumstances force it to do so. Nevertheless, the emergence of problems among core institutions raises substantial fears that the sheer magnitude of China's credit boom since 2009 has produced systemic risks that could spiral out of control for even the best prepared and best equipped governments. Even in a less precarious scenario, the new pressure on banks to reduce risky lending, shore up their reserves and plan for the longer term will translate into less credit for the non-financial economy. Already Chinese reports suggest that small- and medium-sized banks have begun to scale back some preferential low interest rates for buyers of real estate, portending a broader impact.

The State Council, which controls the central bank and is responsible for the government's general drive to tighten controls on the economy for the purposes of reform, will be challenged by the risk that a combination of its actions and weakening international growth could spoil too many investment projects, causing more defaults on unconventional loans tied to underlying assets of unclear value. Thus, even if interbank rates fall back to more normal levels in July or August, the gradual enervation of China's financial system could well continue, greatly complicating the new administration's bold reform efforts by necessitating more financial intervention

“We believe that the domestic Chinese banking system is a mess, with an enormous amount of bad loans, or loans waiting to go bad. The problems of China’s lenders are greater than those of Western banks on the eve of the financial crisis,”..."it seems likely that today’s highpoint will be seen in hindsight as the ultimate warning signal of a coming crash."

China’s great economic leap forward hits the wallThis was supposed to be the Asian century, but the Eastern boom is dying of exhaustion

So here’s how it looks. Years of unsustainable, credit-fuelled growth are brought to a halt by a crushing financial crisis which exposes deep structural flaws at the heart of the economy. Rarely has the assumption of ever-rising living standards looked so vulnerable, with younger generations forced to pay not just for the crippling legacy of debt their parents leave behind, but for the mounting costs of an ageing population and the consequences of decades-long environmental degradation. Economic decline, austerity and inter-generational recrimination seem to beckon as populations adjust to the true mediocrity of their circumstances.

I’m referring to the tired old “developed” economies of the West, right? Actually, no: it’s China where these observations seem more appropriate, and perhaps other emerging market economies said to be about to eclipse the hegemony of the old world, with its lazy ways and sense of entitlement.

Western “declinism” of the sort described by Dambisa Moyo in her book How the West was Lost, and more recently by Stephen King, chief economist at HSBC, in When the Money Runs Out, is still the narrative of our times. But sometimes a sense of perspective is demanded; compared with the challenges faced by China and the rest of the developing world, the relatively minor adjustment to expectations that needs to be made in the West is a stroll in the park.

Forecasts that China will overtake the US as the world’s largest economy over the coming years already look like yesterday’s story as once-explosive development in the East slows to a stall amid growing fears of a Chinese credit crunch. The Asian boom is dying of exhaustion.

As ever, public perceptions trail the reality. For the first time in more than a decade, international investors and business leaders are regularly heard referring to the US as a more attractive proposition than China. Investment flows are going into reverse, and while the US banking system is reviving fast, China’s is heading in the other direction after a period of credit expansion that makes our own look positively pedestrian.

Nor is it just the economics of unbridled, politically directed development that are beginning to fracture; for many Chinese the promise of industrialisation and prosperity is turning into a nightmare of ill health and curtailed life expectancy. The social deprivations of China’s one-child policy meanwhile threaten a demographic time-bomb of far worse proportions than that of the supposedly bankrupt West. There is now every likelihood that China will indeed grow old before it gets rich. One shocking story from the past week vividly demonstrates the massive costs that China’s centrally directed dash for growth is fermenting for the future. According to a study in The Proceedings of the National Academy of Sciences, air pollution has caused an average five-and-a-half year reduction in life expectancy for the 500 million people living north of the Huai River, where use of coal in the home and for electricity generation is most prevalent.

The latest study, pretty much undisputed by the Chinese authorities, adds to mounting evidence of industrial poisoning on a hitherto unimaginable scale. The 2010 Global Burden of Disease Study found that outdoor air pollution caused 1.2 million premature Chinese deaths in 2010, or nearly half the global total.

The fumes are so bad that a growing number of Chinese emigrate, setting in train a potentially devastating brain drain. In a recent interview in the New York Times, the mother of a child made sick by the smog refers to the difference between Britain, where she had studied as a student, and China as heaven and hell.

All industrialisation exacts a heavy human toll in its early years. The miseries of Britain’s industrial revolution are well chronicled. But the speed and scope of China’s attempted catch-up are in a league of their own.

There is also a world of difference between the market-determined development that drove the British and American economic miracles and the state-directed variety of China’s great leap forward.

Politically sponsored advancement rarely occurs without gross misallocation of capital, and in China it seems to be happening on an epic scale. The latest example of China’s capacity overhang is Rongsheng Heavy Industries, the world’s largest private shipbuilder. The collapse in the market for new ships has forced Rongsheng to go cap in hand to the government for a bail-out. It’s said to be an important test of China’s resolve to move from the old, unsustainable, investment-led model of economic development to a more balanced form of advancement, but it is almost certainly one that China will fail. Political connections will ensure Rongsheng survives, and the resulting capacity glut will, in time-honoured fashion, simply be dumped on the rest of the world.

On a global scale, the resulting imbalances require that the deficit nations of the West keep spending to absorb the Chinese surpluses, even though they can no longer afford it. The tragedy for China is that when countries and individuals spend beyond their means, it is always the creditor, and not the debtor, that ends up paying. China’s vast, accumulated surplus of foreign exchange reserves will simply be devalued to oblivion.

By relentlessly pursuing the goal of industrial supremacy, China has made itself into the world’s environmental waste dump, and a hostage to back-door default by Western debtors to boot. Once admired for its dynamism, state-directed capitalism is turning out to be a monstrous anomaly. Chances are that this will be another American century, not the much-predicted Asian one.

All economic data are best viewed as a peculiarly boring genre of science fiction, but Chinese data are even more fictional than most. Add a secretive government, a controlled press, and the sheer size of the country, and it’s harder to figure out what’s really happening in China than it is in any other major economy.

Yet the signs are now unmistakable: China is in big trouble. We’re not talking about some minor setback along the way, but something more fundamental. The country’s whole way of doing business, the economic system that has driven three decades of incredible growth, has reached its limits. You could say that the Chinese model is about to hit its Great Wall, and the only question now is just how bad the crash will be.

Start with the data, unreliable as they may be. What immediately jumps out at you when you compare China with almost any other economy, aside from its rapid growth, is the lopsided balance between consumption and investment. All successful economies devote part of their current income to investment rather than consumption, so as to expand their future ability to consume. China, however, seems to invest only to expand its future ability to invest even more. America, admittedly on the high side, devotes 70 percent of its gross domestic product to consumption; for China, the number is only half that high, while almost half of G.D.P. is invested.

How is that even possible? What keeps consumption so low, and how have the Chinese been able to invest so much without (until now) running into sharply diminishing returns? The answers are the subject of intense controversy. The story that makes the most sense to me, however, rests on an old insight by the economist W. Arthur Lewis, who argued that countries in the early stages of economic development typically have a small modern sector alongside a large traditional sector containing huge amounts of “surplus labor” — underemployed peasants making at best a marginal contribution to overall economic output.

The existence of this surplus labor, in turn, has two effects. First, for a while such countries can invest heavily in new factories, construction, and so on without running into diminishing returns, because they can keep drawing in new labor from the countryside. Second, competition from this reserve army of surplus labor keeps wages low even as the economy grows richer. Indeed, the main thing holding down Chinese consumption seems to be that Chinese families never see much of the income being generated by the country’s economic growth. Some of that income flows to a politically connected elite; but much of it simply stays bottled up in businesses, many of them state-owned enterprises.

It’s all very peculiar by our standards, but it worked for several decades. Now, however, China has hit the “Lewis point” — to put it crudely, it’s running out of surplus peasants.

That should be a good thing. Wages are rising; finally, ordinary Chinese are starting to share in the fruits of growth. But it also means that the Chinese economy is suddenly faced with the need for drastic “rebalancing” — the jargon phrase of the moment. Investment is now running into sharply diminishing returns and is going to drop drastically no matter what the government does; consumer spending must rise dramatically to take its place. The question is whether this can happen fast enough to avoid a nasty slump.

And the answer, increasingly, seems to be no. The need for rebalancing has been obvious for years, but China just kept putting off the necessary changes, instead boosting the economy by keeping the currency undervalued and flooding it with cheap credit. (Since someone is going to raise this issue: no, this bears very little resemblance to the Federal Reserve’s policies here.) These measures postponed the day of reckoning, but also ensured that this day would be even harder when it finally came. And now it has arrived.

How big a deal is this for the rest of us? At market values — which is what matters for the global outlook — China’s economy is still only modestly bigger than Japan’s; it’s around half the size of either the U.S. or the European Union. So it’s big but not huge, and, in ordinary times, the world could probably take China’s troubles in stride.

Unfortunately, these aren’t ordinary times: China is hitting its Lewis point at the same time that Western economies are going through their “Minsky moment,” the point when overextended private borrowers all try to pull back at the same time, and in so doing provoke a general slump. China’s new woes are the last thing the rest of us needed.

No doubt many readers are feeling some intellectual whiplash. Just the other day we were afraid of the Chinese. Now we’re afraid for them. But our situation has not improved.

"China has two things going for it.Their leadership knows Marxism doesn't work, and it has a greater tolerance for political dissent than ours."

"I get the attitude behind the second half of what you say, but I really would not want to be posting this forum in China. You and I would never be seen again."----------------------

True, but the differences between the country pursuing Marxism while shutting down political dissent and China are subtle.

I think the key difference is that the final vestiges of the constitution and the rule of law have Buraq only using the IRS (for the most part) rather than the full power of the state, as seen in China. Although Zimmerman is probably at the leading edge of what comes next.

We've seen two events over the last couple of days that could trigger mass (open source) protest in China.

The first is a watermelon street vendor that was beaten to death with his own scale by a city militia.

The second is a wheelchair bound man that was blew himself up (after warning people to back away), at the Beijing airport. He was crippled by an urban militia for running an informal taxi service with his scooter.

Both incidents have been accelerated by social media -- blogs and a short message service like Twitter -- due to widespread public disatisfaction with the militia system called Chengguan.

Chengguan militias were set up in Chinese cities in 2001 to enforce urban codes (a Chinese variant of "broken windows" in US cities). They are run by local officials with little central oversight. They mainly harrass the informal economy in Chinese cities and are known for corruption ("confliscation") and brutal enforcement. That corrupt brutality is widely resented, particularly now. Why now?

Chinese economic growth is slowing and people are turning to the informal economy in desperation only to run into a brutal, corrupt local militia armed with batons.So, will these two incidents serve to ignite an open source protest that will sweep China -- a watermelon revolution?

Millions of people hitting the streets and blogs under one simple banner: no more corruption!

Perhaps. From afar, these protests look like excellent triggers.

If it doesn't happen now, it will. Remember, China is operating on borrowed time. It's run by a government without any basis for legitimacy other than fast economic growth. To maintain power, that needs to be true, and it's not true anymore.

About a minute ago we were discussing when the Chinese currency would take over the dollar and euro and the global standard. The answer is no time soon. China's problems are well covered in the forum. George Friedman does a nice job of putting them in historical and global context.

"Many have asked when China would find itself in an economic crisis, to which we have answered that China has been there for awhile..."

"the vast majority of Chinese cannot afford the products produced in China, and therefore, stimulus will not increase consumption of those products. ...Stimulating demand so that inefficient factories can sell products is not only inflationary, it is suicidal. The task is to increase consumption, not to subsidize inefficiency."

"The Chinese are thus in a trap. If they continue aggressive lending to failing businesses, they get inflation. That increases costs and makes the Chinese less competitive in exports, which are also falling due to the recession in Europe and weakness in the United States. Allowing businesses to fail brings unemployment, a massive social and political problem. The Chinese have zigzagged from cracking down on lending by regulating informal lending and raising interbank rates to loosening restrictions on lending by removing the floor on the benchmark lending rate and by increasing lending to small- and medium-sized businesses. Both policies are problematic."..."[China will] no longer be the low-wage, high-growth center of the world. Like Japan before it, it will play a different role."

GM's point has considerable merit in our mix. War is a common solution for fascist regimes to their problems and the reality and perception of American military decline makes for mighty temptations, e.g. as has been well-covered in this forum, in the South China Sea.

GM's point [Don't underestimate China] has considerable merit in our mix. War is a common solution for fascist regimes to their problems and the reality and perception of American military decline makes for mighty temptations, e.g. as has been well-covered in this forum, in the South China Sea.

Absolutely. My interest in the fall of China, as a human and a libertarian, is that I would like to see the people freed from the regime. I receive no pleasure or benefit from having them remain a poor, smoggy, polluted third world country.

Part of China is 3rd. world, part of it is first world, kind of like California.

You are right of course, but the number of people living a third world existence there is astounding.

From the Stratfor link, "more than a billion people live in deep poverty"

"the overwhelming poverty of China, where 900 million people have an annual per capita income around the same level as Guatemala, Georgia, Indonesia or Mongolia ($3,000-$3,500 a year), while around 500 million of those have an annual per capita income around the same level as India, Nicaragua, Ghana, Uzbekistan or Nigeria ($1,500-$1,700). China's overall per capita GDP is around the same level as the Dominican Republic, Serbia, Thailand or Jamaica. http://www.stratfor.com/weekly/recognizing-end-chinese-economic-miracle

Major shifts underway in the Chinese economy that Stratfor has forecast and discussed for years have now drawn the attention of the mainstream media. Many have asked when China would find itself in an economic crisis, to which we have answered that China has been there for awhile -- something not widely recognized outside China, and particularly not in the United States. A crisis can exist before it is recognized. The admission that a crisis exists is a critical moment, because this is when most others start to change their behavior in reaction to the crisis. The question we had been asking was when the Chinese economic crisis would finally become an accepted fact, thus changing the global dynamic.

Last week, the crisis was announced with a flourish. First, The New York Times columnist and Nobel Prize-recipient Paul Krugman penned a piece titled "Hitting China's Wall." He wrote, "The signs are now unmistakable: China is in big trouble. We're not talking about some minor setback along the way, but something more fundamental. The country's whole way of doing business, the economic system that has driven three decades of incredible growth, has reached its limits. You could say that the Chinese model is about to hit its Great Wall, and the only question now is just how bad the crash will be."

Later in the week, Ben Levisohn authored a column in Barron's called "Smoke Signals from China." He wrote, "In the classic disaster flick 'The Towering Inferno' partygoers ignored a fire in a storage room because they assumed it has been contained. Are investors making the same mistake with China?" He goes on to answer his question, saying, "Unlike three months ago, when investors were placing big bets that China's policymakers would pump cash into the economy to spur growth, the markets seem to have accepted the fact that sluggish growth for the world's second largest economy is its new normal."

Meanwhile, Goldman Sachs -- where in November 2001 Jim O'Neil coined the term BRICs and forecast that China might surpass the United States economically by 2028 -- cut its forecast of Chinese growth to 7.4 percent.

The New York Times, Barron's and Goldman Sachs are all both a seismograph of the conventional wisdom and the creators of the conventional wisdom. Therefore, when all three announce within a few weeks that China's economic condition ranges from disappointing to verging on a crash, it transforms the way people think of China. Now the conversation is moving from forecasts of how quickly China will overtake the United States to considerations of what the consequences of a Chinese crash would be. Doubting China

Suddenly finding Stratfor amid the conventional wisdom regarding China does feel odd, I must admit. Having first noted the underlying contradictions in China's economic growth years ago, when most viewed China as the miracle Japan wasn't, and having been scorned for not understanding the shift in global power underway, it is gratifying to now have a lot of company. Over the past couple of years, the ranks of the China doubters had grown. But the past few months have seen a sea change. We have gone from China the omnipotent, the belief that there was nothing the Chinese couldn't work out, to the realization that China no longer works.

It has not been working for some time. One of the things masking China's weakening has been Chinese statistics, which Krugman referred to as "even more fictional than most." China is a vast country in territory and population. Gathering information on how it is doing would be a daunting task, even were China inclined to do so. Instead, China understands that in the West, there is an assumption that government statistics bear at least a limited relationship to truth. Beijing accordingly uses its numbers to shape perceptions inside and outside China of how it is doing. The Chinese release their annual gross domestic product numbers in the third week of January (and only revise them the following year). They can't possibly know how they did that fast, and they don't. But they do know what they want the world to believe about their growth, and the world has believed them -- hence, the fantastic tales of economic growth.

China in fact has had an extraordinary period of growth. The last 30 years have been remarkable, marred only by the fact that the Chinese started at such a low point due to the policies of the Maoist period. Growth at first was relatively easy; it was hard for China to do worse. But make no mistake: China surged. Still, basing economic performance on consumption, Krugman notes that China is barely larger economically than Japan. Given the compounding effects of China's guesses at GDP, we would guess it remains behind Japan, but how can you tell? We can say without a doubt that China's economy has grown dramatically in the past 30 years but that it is no longer growing nearly as quickly as it once did.

China's growth surge was built on a very unglamorous fact: Chinese wages were far below Western wages, and therefore the Chinese were able to produce a certain class of products at lower cost than possible in the West. The Chinese built businesses around this, and Western companies built factories in China to take advantage of the differential. Since Chinese workers were unable to purchase many of the products they produced given their wages, China built its growth on exports.

For this to continue, China had to maintain its wage differential indefinitely. But China had another essential policy: Beijing was terrified of unemployment and the social consequences that flow from it. This was a rational fear, but one that contradicted China's main strength, its wage advantage. Because the Chinese feared unemployment, Chinese policy, manifested in bank lending policies, stressed preventing unemployment by keeping businesses going even when they were inefficient. China also used bank lending to build massive infrastructure and commercial and residential property. Over time, this policy created huge inefficiencies in the Chinese economy. Without recessions, inefficiencies develop. Growing the economy is possible, but not growing profitability. Eventually, the economy will be dragged down by its inefficiency. Inflation vs. Unemployment

As businesses become inefficient, production costs rise. And that leads to inflation. As money is lent to keep inefficient businesses going, inflation increases even more markedly. The increase in inefficiency is compounded by the growth of the money supply prompted by aggressive lending to keep the economy going. As this persisted over many years, the inefficiencies built into the Chinese economy have become staggering.

The second thing to bear in mind is the overwhelming poverty of China, where 900 million people have an annual per capita income around the same level as Guatemala, Georgia, Indonesia or Mongolia ($3,000-$3,500 a year), while around 500 million of those have an annual per capita income around the same level as India, Nicaragua, Ghana, Uzbekistan or Nigeria ($1,500-$1,700). China's overall per capita GDP is around the same level as the Dominican Republic, Serbia, Thailand or Jamaica. Stimulating an economy where more than a billion people live in deep poverty is impossible. Economic stimulus makes sense when products can be sold to the public. But the vast majority of Chinese cannot afford the products produced in China, and therefore, stimulus will not increase consumption of those products. As important, stimulating demand so that inefficient factories can sell products is not only inflationary, it is suicidal. The task is to increase consumption, not to subsidize inefficiency.

The Chinese are thus in a trap. If they continue aggressive lending to failing businesses, they get inflation. That increases costs and makes the Chinese less competitive in exports, which are also falling due to the recession in Europe and weakness in the United States. Allowing businesses to fail brings unemployment, a massive social and political problem. The Chinese have zigzagged from cracking down on lending by regulating informal lending and raising interbank rates to loosening restrictions on lending by removing the floor on the benchmark lending rate and by increasing lending to small- and medium-sized businesses. Both policies are problematic.

The Chinese have maintained a strategy of depending on exports without taking into account the operation of the business cycle in the West, which means that periodic and substantial contractions of demand will occur. China's industrial plant is geared to Western demand. When Western demand contracted, the result was the mess you see now.

The Chinese economy could perhaps be growing at 7.4 percent, but I doubt the number is anywhere near that. Some estimates place growth at closer to 5 percent. Regardless of growth, the ability to maintain profit margins is rarely considered. Producing and selling at or even below cost will boost GDP numbers but undermines the financial system. This happened to Japan in the early 1990s. And it is happening in China now.

The Chinese can prevent the kind of crash that struck East Asia in 1997. Their currency isn't convertible, so there can't be a run on it. They continue to have a command economy; they are still communist, after all. But they cannot avoid the consequences of their economic reality, and the longer they put off the day of reckoning, the harder it will become to recover from it. They have already postponed the reckoning far longer than they should have. They would postpone it further if they could by continuing to support failing businesses with loans. They can do that for a very long time -- provided they are prepared to emulate the Soviet model's demise. The Chinese don't want that, but what they do want is a miraculous resolution to their problem. There are no solutions that don't involve agony, so they put off the day of reckoning and slowly decline.China's Transformation

The Chinese are not going to completely collapse economically any more than the Japanese or South Koreans did. What will happen is that China will behave differently than before. With no choices that don't frighten them, the Chinese will focus on containing the social and political fallout, both by trying to target benefits to politically sensitive groups and by using their excellent security apparatus to suppress and deter unrest. The Chinese economic performance will degrade, but crisis will be avoided and political interests protected. Since much of China never benefited from the boom, there is a massive force that has felt marginalized and victimized by coastal elites. That is not a bad foundation for the Communist Party to rely on.

The key is understanding that if China cannot solve its problems without unacceptable political consequences, it will try to stretch out the decline. Japan had a lost decade only in the minds of Western investors, who implicitly value aggregate GDP growth over other measures of success such as per capita GDP growth or full employment. China could very well face an extended period of intense inwardness and low economic performance. The past 30 years is a tough act to follow.

The obvious economic impact on the rest of the world will fall on the producers of industrial commodities such as iron ore. The extravagant expectations for Chinese growth will not be met, and therefore expectations for commodity prices won't be met. Since the Chinese economic failure has been underway for quite awhile, the degradation in prices has already happened. Australia in particular has been badly hit by the Chinese situation, just as it was by the Japanese situation a generation ago.

The Chinese are, of course, keeping a great deal of money in U.S. government instruments and other markets. Contrary to fears, that money will not be withdrawn. The Chinese problem isn't a lack of capital, and repatriating that money would simply increase inflation. Had the Chinese been able to put that money to good use, it would have never been invested in the United States in the first place. The outflow of money from China was a symptom of the disease: Lacking the structure to invest in China, the government and private funds went overseas. In so doing, Beijing sought to limit destabilization in China, while private Chinese funds looked for a haven against the storm that was already blowing.

Rather than the feared repatriation of funds, the United States will continue to be the target of major Chinese cash inflows. In a world where Europe is still reeling, only the United States is both secure and large enough to contain Chinese appetites for safety. Just as Japanese investment in the 1990s represented capital flight rather than a healthy investment appetite, so the behavior we have seen from Chinese investors in recent years is capital flight: money searching for secure havens regardless of return. This money has underpinned American markets; it is not going away, and in fact more is on the way.

The major shift in the international order will be the decline of China's role in the region. China's ability to project military power in Asia has been substantially overestimated. Its geography limits its ability to project power in Eurasia, an endeavor that would require logistics far beyond China's capacity. Its naval capacity is still limited compared with the United States. The idea that it will compensate for internal economic problems by genuine (as opposed to rhetorical) military action is therefore unlikely. China has a genuine internal security problem that will suck the military, which remains a domestic security force, into actions of little value. In our view, the most important shift will be the re-emergence of Japan as the dominant economic and political power in East Asia in a slow process neither will really want.

China will continue to be a major power, and it will continue to matter a great deal economically. Being troubled is not the same as ceasing to exist. China will always exist. It will, however, no longer be the low-wage, high-growth center of the world. Like Japan before it, it will play a different role.

In the global system, there are always low-wage, high-growth countries because the advanced industrial powers' consumers want to absorb goods at low wages. Becoming a supplier of those goods is a major opportunity for, and disruptor to, those countries. No one country can replace China, but China will be replaced. The next step in this process is identifying China's successors.

Read more: Recognizing the End of the Chinese Economic Miracle | StratforFollow us: @stratfor on Twitter | Stratfor on Facebook

Seeing Krugman's take on China must be a big relief to the Chinese leadership. The fact that GF treats Krugman with anything but contempt makes me question GF.

Good thing the stuff below no way applies to us:

"Because the Chinese feared unemployment, Chinese policy, manifested in bank lending policies, stressed preventing unemployment by keeping businesses going even when they were inefficient. China also used bank lending to build massive infrastructure and commercial and residential property. Over time, this policy created huge inefficiencies in the Chinese economy. Without recessions, inefficiencies develop. Growing the economy is possible, but not growing profitability. Eventually, the economy will be dragged down by its inefficiency. Inflation vs. Unemployment

As businesses become inefficient, production costs rise. And that leads to inflation. As money is lent to keep inefficient businesses going, inflation increases even more markedly. The increase in inefficiency is compounded by the growth of the money supply prompted by aggressive lending to keep the economy going. As this persisted over many years, the inefficiencies built into the Chinese economy have become staggering."

"Seeing Krugman's take on China must be a big relief to the Chinese leadership. The fact that GF treats Krugman with anything but contempt makes me question GF."

"As good/great as Stratfor often is on geo-politics in equal measure it can be quite the Keynesian mediocrity on economics."-----------------

That was my reaction too. I assume there is a serious, Princeton economist / Nobel Laureate residing somewhere in Krugman's brain, not just the partisan shill, caricature of a columnist that he plays over at the NYTimes. I just haven't seen any evidence of it. It detracts from the piece to quote Krugman but what Friedman is saying - Crafty had it in his title - is that even these people are now admitting what we have been saying for quite a while.

Edward Wong’s terrific front-page article in The New York Times on Friday is as good an encapsulation of the issues currently facing China and its economy as anything you’re likely to read on the subject. As it tries to move from a fast-growing, export-oriented, developing economy to a more mature economy, it keeps bumping up against problems that could prevent it from becoming the kind of economic power it so clearly longs to be. These problems are almost entirely self-inflicted.

Wong’s article was about, of all things, infant formula. Specifically, it was about how Chinese parents with connections and money scramble to buy formula abroad, even though there is plenty available in China. They hire people who will go into stores in Britain and elsewhere and buy formula for them. Or they buy formula that has been smuggled in from Hong Kong — where smuggling infant formula is now a serious crime. Mainly, Chinese parents want to ensure that the formula they are feeding their babies has never been touched by a Chinese company.

The reason is obvious. In 2008, six babies died and some 300,000 became ill after their mothers fed them baby milk products that were tainted with the chemical melamine. Ever since, Chinese mothers haven’t trusted domestically made baby milk products — starting with formula.

In fact, as I learned during my recent visit to China, Chinese consumers don’t trust a lot of Chinese-made goods. In recent years, there have been food scandals surrounding cooking oil, eggs and meat, for starters. A few months ago, according to Time magazine, three people were caught processing pigs that had died of infectious diseases. A few years ago, contamination of Chinese-produced heparin, the blood-thinner, was linked to 81 deaths. Chinese consumers don’t even favor Chinese cars — foreign models dominate the market — because they fear that someone may have taken a shortcut (or worse) that will cause the car to die.

So problem No. 1: At a time when China is trying to build a domestic economy to match its export economy, there is a complete lack of faith in Chinese companies. “It is not about branding,” an American businessman living in Shanghai told me (he feared consequences to his business if he let me use his name). Rather, he said, there is a sense among consumers that no matter what the industry, too many Chinese businesspeople are willing to scam their own customers to make a buck.

With corner-cutting deeply ingrained as a Chinese business practice, it’s really up to the government to change that ethos through regulation and enforcement. But while the central government is more than happy to pass nice-sounding laws, there is virtually no enforcement, and no real culture of regulation either. That’s problem No. 2. Provincial governments that are supposed to oversee, say, the food supply, are often either in on the scam, or look the other way because they fear that a crackdown might impede economic growth. And officials are evaluated almost exclusively on the basis of growth. Problem No. 3: bad incentives.

And if your car does break down in six months because a supplier sold faulty parts — or your child dies from tainted infant formula? There’s not a thing you can do. Yes, when a big scandal breaks, some crooks go to prison, but even the biggest scandals don’t lead to systematic change. Nor is there any way to seek recompense in the courts; in the West, that has long served to help keep companies on the straight and narrow. The lack of a real rule of law is problem No. 4.

As Wong notes in his article, the government is now investigating foreign companies selling infant formula in China for price-fixing. (Since the scandal, the price of a can of foreign formula has risen by 30 percent.) Whether there is price-fixing or not — market forces are a more likely culprit — this response is exactly the problem: instead of enforcing regulations that would give consumers confidence in their own country’s products, the government instead is finding ways to make life more difficult for those who make products its citizens want.

In the United States, of course, it has become religion among conservatives to denounce regulation, saying it stifles business and hinders economic growth. But consider: At the turn of the last century, America was as riddled with scam artists as China is today. Snake oil salesmen — literally — abounded. Food safety was a huge issue. In 1906, however, Upton Sinclair published “The Jungle,” his exposé-novel about the meatpacking industry. That book, pointed out Stanley Lubman, a longtime expert in Chinese law, in a recent blog post in The Wall Street Journal, is what propelled Theodore Roosevelt to propose the Food and Drug Administration. Which, in turn, reformed meat-processing — among many other things — and gave consumers confidence in the food they ate and the products they bought.

China: Measures to 'Improve' One-Child Policy Are Under ReviewBeijing Faces Calls for More Personal Freedom

BEIJING—China's authorities are studying measures to "improve the one-child policy" by allowing some families to have a second child, the official Xinhua News Agency reported late Friday, citing an official with the national family planning agency.

"Our commission is organizing research on the size, quality, structure and distribution of the population so that we can propose plans to improve the [one-child] policy," Mao Qun'an, director of the propaganda office at the National Health and Family Planning Commission, told Xinhua.

"We'll have to move cautiously and coordinate between current situations and long-term objectives," said Mr. Mao, without elaborating.

Beijing is under pressure to ease its grip on child birth in response to calls for more personal freedom in an increasingly affluent society. Such a move is also aimed at offsetting the financial effects of an aging society and addressing potential labor shortages in the years ahead. The nation's working population declined for the first time in decades last year due to the nation's tight controls on child birth.

Despite Mr. Mao's cautious rhetoric, expectations are building for Beijing to loosen controls on the nation's decadeslong one-child policy.

The 21st Century Business Herald on Friday cited unnamed sources with the national family planning agency as saying such moves could be expected either late this year or next year.

Some economists agree. The window for population-policy reform could be around the Communist Party's annual meeting in the fourth quarter of this year or around the National People's Congress meeting early next year, Bank of America Merrill Lynch economist Lu Ting said in a note released Saturday.

An estimated 9.5 million "incremental babies" will be born if such a move takes place as expected, Mr. Lu said.

China limits couples to only one child. Violators can face financial penalties. Minority groups are exempt, and anyone with enough money can get around penalties for having a second child. Rural families whose first child is a girl may have a second child, as can married couples who are both themselves only children.

In many rural areas, the restrictions are routinely ignored, though policies in the cities have been more tightly enforced.

The rapid rise of interbank lending markets since 2011 shows that Chinese banks and other financial institutions, especially local and provincial ones, continue to struggle to boost liquidity and cash flow as economic growth slows. Though interbank markets are not a nationwide phenomenon, their continued expansion and growing sophistication could create systemic risks for China's financial system.Analysis

Interbank loan and bond markets have been staples of the Chinese financial system since the 1990s. Until recently, however, they accounted for a comparatively small portion of total assets held by listed Chinese banks -- roughly 1.6 trillion yuan ($261 billion), or 3.6 percent of total banking sector assets, in 2006. For most of the 2000s, interbank markets in China, like those in other countries, provided short-term, targeted relief for cash-strapped banks. But because interbank loans were available only to commercial banks, and because commercial banks in China are required to maintain high levels of liquid reserves at all times, demand for interbank loans remained relatively low. Moreover, high reserve requirements for commercial banks minimized the risks of interbank loans.

This began to change after the 2008-2009 financial crisis, particularly after the central government's clampdown in late 2011 on speculative real estate markets and the local government financing vehicles behind them. Suddenly, with residential property markets increasingly squeezed, the Chinese banks that were still capital-rich scrambled to find new investment outlets that could deliver similarly high rates of return.

The pressure was especially high for small- to medium-sized local and provincial banks. They enjoyed neither the enormous depositor bases of the largest commercial banks, such as the Bank of China and China Construction Bank, nor these banks' privileged position as lenders of choice to key state-owned enterprises. Smaller banks' close connection to and heavy reliance on demand from local governments throughout the post-2008 boom only aggravated their pain when, on Beijing's orders, demand suddenly dried up. Banks and their wealthy investors were forced to look for other conduits for their capital.

The years following Beijing's crackdown on local government financing vehicles saw a spike in the number and size of non-traditional lending institutions, such as trust companies, mutual funds, peer-to-peer lenders and "wealth management products" distributed mostly by small- and medium-sized banks -- not to mention local branches of larger banks. These informal investment products came about to meet a simple need: spending money.

Indeed, after four years of government-directed credit creation, China's banking system was flush with capital that had to be put somewhere. When capital could no longer flow into property markets through traditional channels, investment had to go through non-traditional channels. Anecdotal reports suggest that by late 2012 much of the capital generated by sales of wealth management products was redirected back into those same non-traditional products. As a result, assets in informal lending markets inflated rapidly.

By mid-2012, the line blurred between formal and informal lenders at the local level. What remained was a network of local and provincial financial actors -- not only banks but also trust companies and mutual funds -- all working with and through one another in search of higher returns. In this context, local interbank loan markets emerged as a key if temporary buffer to help cash-strapped and increasingly intertwined local lenders avoid short-term liquidity crunches. When non-bank lenders and investors entered interbank markets, the demand for short-term loans multiplied, especially as slowing economic activity gave way to defaults on trust and wealth management products in late 2012. By March 2013 the total value of assets held in interbank markets reached 11.6 trillion yuan, nearly 10 times their value in 2006 and about 12 percent of China's total banking sector assets.

As more and more diverse actors began borrowing and lending on interbank markets, a new kind of player emerged: the intermediary. Industrial Bank, a midsized lender based in Fujian province and known colloquially as China's "Interbank King," best exemplifies this kind of intermediary. More than 36 percent of the bank's total assets are tied to interbank markets (the most of any Chinese bank), and in the first half of 2013 interbank operations accounted for some 50 percent of its profits -- which, notably, grew by 26.52 percent in the same time frame, more than double most profit expectations for China's largest commercial banks.

The key to Industrial Bank's success was not that it bought or sold loans or bonds on interbank markets; rather, it was that it brought together other banks looking to borrow and lend. All the while it profited from the transaction fees. This makes Industrial Bank's profit growth one of the clearest indicators of strongly rising demand for interbank loans currently, despite Beijing's attempt to crack down on excessive interbank activity. Such crackdowns have taken a variety of forms, from the People's Bank's reticence to inject liquidity into interbank markets in June to the more recent decision by the central bank to ban Baoshang Bank Co., a local lender in Inner Mongolia, from participating in interbank bond transactions for two years. Local Problems

A defining feature of interbank lending markets is that they are localized. Certainly, China's biggest state-owned commercial banks with nationwide reach are exposed to interbank operations. But comparatively, these activities constitute a small portion of their lending and purchases. Moreover, given banks' large depositor bases and high reserves requirement ratio of 20 percent (the United States' is 10 percent), the largest commercial firms run little risk of an outright cash crunch due to tight liquidity conditions on the interbank markets.

In addition to their comparative disadvantage to the "Big Four" centrally administered state banks, the smaller banks that are most active in interbank lending markets are far less receptive to central government directives. These banks include informal offshoots and local branches of larger banks, and they are all especially resilient to directives aimed at curbing credit and investment growth. Instead, their interests are closely aligned with those of local governments and local economies -- namely, growth regardless of wider market trends. Major state-owned banks with large balance sheets may tolerate stagnating investment income, but smaller banks, which require cash flow simply to stay afloat, cannot.

Their position is made worse by the overwhelming concentration of nonperforming loans at the local level. All of these loans were given out on credit during the post-2008 boom to local governments with little capacity to repay. For these banks, the ability to get a small, short-term loan on interbank markets is therefore critical in meeting reserve requirements and making basic payments to investors.

On the one hand, the concentration of interbank operations among smaller banks helps Beijing. It reduces the risk of systemwide collapse by isolating the riskiest elements of the banking sector far from the more important Big Four state-owned commercial banks. However, it makes effective central management and coordination of interbank operations nationwide virtually impossible. The most Beijing can do is pre-emptively punish irresponsible local banks as it did with Baoshang. Otherwise, it can do little but wait until seasonal liquidity crunches create an opportunity for it to warn banks that are overly exposed to interbank markets, such as Industrial Bank or China Everbright, a Shanghai-based lender that defaulted on a wealth management product earlier this year. Both measures fall far short of addressing the underlying problem of small- and medium-sized banks' need for higher returns on their investment than the economy can now provide.

The key risk for Beijing is that as demand for interbank loans and bonds grows, more companies will adopt the business model of Industrial Bank, and the matchmaking operations of Industrial Bank and its midsized peers will, in turn, become more far-reaching and sophisticated. For Beijing, localized defaults on one or two lending products, or even countywide crises in disparate regions, are manageable precisely because they are isolated and localized.

But banning individual banks in distant provinces does nothing to redress the rising demand for interbank operations, which gives way to increasingly interconnected networks of interbank lending tied together by fast-growing intermediaries such as Industrial Bank. In the coming months, Beijing's task will be to stem the tide of demand that companies like Industrial Bank are both riding and propelling forward.

I have posted here many times about China being less than it seems due to dishonest bookkeeping, unsound demographics, and the fact that the country has become a toxic dump. According to this POTH piece, the Chinese government begins to grapple with the last of these:

China’s Plan to Curb Air Pollution Sets Limits on Coal Use and VehiclesBy EDWARD WONGPublished: September 12, 2013

BEIJING — The Chinese government announced an ambitious plan on Thursday to curb air pollution across the nation, including setting some limits on burning coal and taking high-polluting vehicles off the roads to ensure a drop in the concentration of particulate matter in cities.

The government is responding to criticism over the abysmal condition of the country’s air, soil and water.

The plan, released by the State Council, China’s cabinet, filled in a broad outline that the government had issued this year. It represents the most concrete response yet by the Communist Party and the government to growing criticism over allowing the country’s air, soil and water to degrade to abysmal levels because of corruption and unchecked economic growth.

The criticism has been especially pronounced in some of China’s largest cities, where anxious residents grapple with choking smog that can persist for days and even weeks. In January, the concentration of fine particulate matter in Beijing reached 40 times the exposure limit recommended by the World Health Organization.

Environmental advocates, including some at Greenpeace East Asia, said the plan did not go far enough, while others praised it for at least acknowledging some of the basic causes of the country’s chronic air pollution. But there was wide agreement that the ultimate test would come in how it is carried out and enforced.

Chinese cities suffer from some of the worst air pollution in the world, with outdoor pollution having accounted for 1.2 million premature deaths in China in 2010, according to the 2010 Global Burden of Disease Study. Increasingly, air pollution is changing everyday life. Face masks are becoming more ubiquitous in the cities, and some affluent parents increasingly choose schools more for their air filtration systems than for their academics. The environment is emerging as a potent political issue.

For years China has had an array of strict environmental standards on paper, and its leaders talk constantly about the need to improve the environment. But enforcement has been lax, and the environment has continued to deteriorate at an alarming rate.

“The plan successfully identifies the root cause of air pollution in China: China’s industrial structure,” said Ma Jun, a prominent environmental advocate. “Industrialization determines the structure of energy consumption. If China does not upgrade its coal-dependent industries, coal consumption can never be curbed.” he said. “The key to preventing air pollution is to curb coal burning — China burns half of all the coal consumed in the world.”

Under the new plan, concentrations of fine particulate matter must be reduced by 25 percent in the Beijing-Tianjian-Hebei area in the north, 20 percent in the Yangtze River Delta in the east and 15 percent in the Pearl River Delta in the south, compared with 2012 levels.

All other cities must reduce the levels of larger particulate matter, known as PM 10, by 10 percent. It is unclear why the plan calls for a looser standard for other cities, since the fine particulate matter, known as PM 2.5, is considered deadlier than PM 10 because it can penetrate deep into the lungs and enter the bloodstream

The plan said Beijing must also bring its average concentration of PM 2.5 down to 60 micrograms per cubic meter or less. That would be two and a half times the recommended exposure limit set by the World Health Organization.

For years, Chinese officials kept measurements of PM 2.5 from the public. But many Chinese in Beijing turned to a Twitter feed from the United States Embassy to see the hourly PM 2.5 reading from a monitoring machine on the embassy rooftop. That, in turn, put pressure on the government to have cities start releasing their PM 2.5 measurements. Beijing began reporting PM 2.5 levels in January 2012, and the official Xinhua news agency has reported that 74 cities are supposed to be releasing their PM 2.5 data this year.

On Thursday, pollution climbed to levels that the embassy rated “very unhealthy,” with a PM 2.5 concentration at 10 p.m. at 213 micrograms per cubic meter. Much of the city’s downtown skyline was obscured by a thick haze.

Coal consumption has grown rapidly in China, and the plan places only modest limits on consumption, with coal to account for no more than 65 percent of energy use in 2017, compared with around 67 percent last year. Some of the plan’s critics said they were disappointed that there were no specific limits on coal consumption by region. The plan allows local governments to set those limits on their own.

“Instead of setting a goal to reduce coal burning for each province, the action plan gives each province the power to set goals for themselves, which leads to the goals being very conservative,” said Huang Wei, who works on climate and energy advocacy at Greenpeace East Asia.

The plan addressed vehicle emissions by removing all high-polluting “yellow label” vehicles that were registered before the end of 2005 from the roads by the end of 2015. In the three regions with heavy industry, all such vehicles are to be taken off the roads by 2015, and the same for all of China by 2017.

In those three regions, gasoline and diesel of a high standard, China V, will be provided in certain cities. But the plan did not set targets for new vehicle emissions standards, which some environmental advocates say is a major omission. “We had been waiting for months for the new action plan,” Ms. Huang said. “We thought it might be a pivot point in history. Now it’s here, and we think it has very much fallen short of our expectations.”

A recent power struggle within Taiwan's ruling Kuomintang corresponds with the country's deep-seated political and ethnic disparities. Like the island itself, the party is roughly divided between early generations of Taiwanese residents, who consider themselves natives, and immigrants who came to Taiwan from China in the 1940s, often referred to as "mainlanders." This explains why Taiwanese President Ma Ying-jeou's recent move against a rival underscores the island's inherent political issues. On Sept. 11, Ma -- a mainlander -- revoked the party membership of Wang Jin-pyng, the country's powerful indigenous parliamentary speaker.

It is unclear what long-term consequences will come about from Wang's removal. Certainly it will further aggravate tensions within the Kuomintang, but given Wang's popularity and influence, it could also lead to the creation of a viable third party that could threaten the Kuomintang's political dominance. Otherwise, Wang could align himself with the political opposition. Any political realignment will concern Beijing, which considers the Kuomintang's aversion to independence critical for easing cross-strait tensions.Analysis

The current spat began over allegations that Wang misused political power. He stood accused of interfering in a court case and of lobbying a former justice minister to appeal the acquittal of a lawmaker for the opposition Democratic Progressive Party. As a result, Wang lost his party membership, albeit temporarily. (He later appealed the dismissal in court successfully and has since been reinstated.) Nonetheless, his expulsion will likely end his 14-year stint as the head of the parliament.Removing an Obstacle

In some sense, the scandal was merely an extension of a long-standing power struggle between Ma and Wang and their respective bases of support. The struggle became public in 2005, when the two officials each contended for the Kuomintang chairmanship. Ma won with 72.4 percent of the votes. However, Wang remained very influential, due in part to nearly four decades of experience and to extensive political networks both inside and outside the Kuomintang. He has used his position and influence to challenge the Ma presidency for years. For example, he supposedly has obstructed the passage of several important presidential proposals -- even though he and Ma share allegiance to the same party.

The timing of the dismissal is notable. Ma's support is currently dwindling, so he is promoting several policies that he hopes will salvage his career as elections approach. In this context, Wang's expulsion is widely seen as an effort to consolidate power and remove an obstacle that could block some of these policy proposals in the legislature. Among the proposals are a nuclear plant bill and a cross-strait service trade agreement, a key follow-up to the milestone cross-strait Economic Cooperation Framework Agreement signed in 2010.

Ma has tried to portray Wang's dismissal as an effort to protect the integrity of the justice system, but the public is unconvinced. A recent survey showed that only 11 percent of Taiwanese citizens support Ma. By comparison, Wang's support rate is a little higher than 60 percent. Lackluster support may prevent Ma from implementing his policy proposals.Polarization

These challenges become more pronounced in Taiwan's polarized political atmosphere. An overarching theme in contemporary Taiwanese politics and society, this polarization stems from the island's geopolitical environment and divided ethnicity -- namely, the mainlanders who fled China in the mid-20th century and the native populations that have resided on the island for a much longer period. The former group is a minority, comprising only 15 percent of the population. Consequently, the country broadly boasts two predominant identities -- a Taiwanese national identity and an ethnic Chinese identity -- and this duality has shaped the debate over Taiwanese independence for years.

Taiwan: A Party Dismissal Bodes Ill for the Kuomintang

In Taiwan, there are several political parties, but only two dominate politics. The Kuomintang is generally regarded as the party of the mainlanders, and the Democratic Progressive Party, with its Taiwanese nationalist and pro-independence agenda, is regarded as the party of the indigenous Taiwanese. The Kuomintang ruled in a single-party system until the 1980s, when it faced accusations of over-dominance and corruption. Unsurprisingly, indigenous parties began to grow more popular, so Kuomintang politicians were forced to widen their appeal to the indigenous to secure their rule. In fact, Lee Teng-hui, the president who oversaw Taiwan's democratic transition at the end of the 20th century, was an indigenous Kuomintang politician.

Thus, ethnic and political divisions between mainlanders and natives also exist within the Kuomintang. This is why Wang's dismissal bodes ill for intra-Kuomintang politics. Wang is among the most prominent members of the indigenous camp, and he helped secure support for the party in southern Taiwan, an indigenous political stronghold. But what could hurt the Kuomintang even more is if Wang, given his influence and networks, creates his own party ahead of the 2014 and 2016 elections as some observers have suggested. This actually happened in the early 2000s, when James Soong broke off from the Kuomintang and ran for the presidency on the People First Party ticket. He poached votes from the Kuomintang, effectively giving the presidency to the Democratic Progressive Party's Chen Shui-bian.

Even if he does not form his own party, Wang could still align with the opposition. As an indigenous politician, he and the Democratic Progressive Party have similar agendas and a shared power base.Beijing's Concern

China would be concerned by a political realignment in Taiwan. Although Beijing has little influence in Taipei, it has long considered Taiwan's mainlanders a proxy group through which it could confer some degree of political and economic influence. China's ultimate goal, of course, is eventual reunification, and Beijing believes it has a much better chance, albeit a remote one, of achieving this goal with the Kuomintang in power. At the very least, the Kuomintang would prevent the island from distancing itself further from Chinese interests. To that end, Beijing has attempted to cultivate mainlander politicians, catering to their power bases through political or economic incentives.

Since 2008, the Kuomintang has made several proposals to integrate economically with mainland China. And yet its strategy is to benefit from China's economic success while carving out enough space to maintain its autonomy. Beijing understands that as long as the possibility for reunification exists, there is little reason to force the issue. Still, the Kuomintang's dissonance and its declining popularity represent a serious challenge to the Chinese leadership. Beijing does not want to see its cross-strait strategy complicated by political tensions and unpredictability in Taiwan.

Read more: Taiwan: A Party Dismissal Bodes Ill for the Kuomintang | Stratfor

CHICAGO — NEXT month, President Xi Jinping and Prime Minister Li Keqiang will use an important meeting — the so-called Third Plenum of the Communist Party’s 18th National Congress — to unveil China’s priorities for reforming economic policy for the next decade.

Yet because it will probably decide only general policies, leaving the specifics for later, some cynics have already begun to dismiss the reforms as too little, too timid and too late. They note that a decade ago, a previous generation of leaders failed to reduce the influence of state-owned enterprises and to complete the economic reforms of the 1990s.

But I believe the prospects for restructuring China’s economy — bolstering the role of the market, expanding opportunities for small and medium-size businesses, allocating capital more efficiently and improving the balance between consumption and investment — are better than at any point since the 1990s. At a time when global growth remains sluggish, reinvigorating such reforms is more important than ever to the world economy.

In speech after speech, Mr. Xi and Mr. Li have put their political capital on the line by promoting economic reform. They have drawn up blueprints and adopted pilot programs — like a free-trade zone in Shanghai — that will bolster the market and rationalize the allocation of capital, for instance by permitting more foreign competition and greater fluctuation of interest rates.

Other reforms, including liberalizing deposit rates, still need to be put in place, but an experiment to liberalize lending rates is a very positive step. So is Beijing’s signal that it might open more sectors of its economy to competition through a bilateral investment treaty with the United States.

Second, China’s new leaders are strong enough to press for change. The history of Chinese economic reform suggests that vigorous central leadership is essential. Deng Xiaoping was the determined architect behind China’s initial reforms in 1978 and their reinvigoration in 1992. Zhu Rongji, the prime minister under President Jiang Zemin, pushed through reforms of the taxation system and state-controlled industries that paved the way for China’s joining the World Trade Organization in 2001.

But in the decade or so since then, reforms stalled, and a major cause was the evaporation of political commitment in Beijing. The new leaders have signaled that they are prepared to move. An anti-corruption campaign begun by Mr. Xi demonstrates a willingness to take on even the most politically sensitive pillars of the state-led economy.

Third, China no longer has the luxury to delay needed reforms. China’s economic output expanded nearly sixfold between 2002 and 2012, from $1.5 trillion to $8.3 trillion, but that growth fostered complacency. True, it weathered the financial crisis through giant spending on public works, but that only put off the day of reckoning. The presumption that China can simply grow its way out of any problems no longer holds. Growth is slowing, inequality has widened, provincial and local government debts have climbed. China’s export-oriented sectors face harsh headwinds, from sluggish consumer demand in advanced markets to rising labor costs at home.

Fourth, public expectations for change are higher than ever. When the new leaders were appointed last year, they were compared favorably to their immediate predecessors, President Hu Jintao and Prime Minister Wen Jiabao. But the honeymoon for Mr. Xi and Mr. Li, who took over last November, is over.

Increasingly, they are being measured against the bold Mr. Jiang, the Communist Party leader from 1989 to 2002, and Mr. Zhu, the prime minister from 1998 to 2003. And so the necessity for action is greater.

Momentum is building for reforms that would introduce market prices for oil, gas and other natural resources so that prices better reflect supply and demand, rather than official fiat. Distorted pricing has been one cause of China’s energy inefficiency and environmental degradation. Like the new steps toward liberalizing energy prices, Shanghai’s new free-trade zone is another positive indicator. More is needed — broader access to capital, greater investment options and protections from the risk of haphazard capital flows — if Shanghai is to become a global financial center.

A new round of fiscal reforms is also likely, leading to more rational allocation of resources between the central and local governments, which are struggling to rebuild weakened rural pension and health care systems and manage the largest urbanization in human history in a sustainable way, while paying for unfunded mandates from Beijing and maintaining job growth.

This vast array of specific reforms can’t be achieved at a stroke, and certainly not at a single party gathering. But the decisions likely to be taken in November will set China’s economy in a positive — and lasting — new direction. Advanced economies, like the United States and the European Union, depend on it as much as China does.

Henry M. Paulson Jr., the secretary of the Treasury from 2006 to 2009 and a former chairman and chief executive of Goldman Sachs, is chairman of the Paulson Institute, which promotes sustainable growth and a cleaner environment in the United States and China.

Beijing appears to be on track, yet again, to hit its official growth target. According to China's National Bureau of Statistics, gross domestic product rose 7.8% in the third quarter of 2013, well on its way toward hitting the official target of 7.5% GDP growth for the year.

But can these numbers be trusted? Beijing has a long tradition of setting and then claiming to exceed high growth targets, which makes growth appear both rapid and stable. For years, China reported much less volatile economic growth than other developing nations, but lately volatility has all but disappeared. Since the start of 2012, China has reported a GDP growth rate within a few decimal points of the official target—every quarter.

Another reason to question these numbers is that China's second most powerful official has. In a 2007 cable revealed by WikiLeaks in late 2010, Chinese Premier Li Keqiang was quoted acknowledging that official GDP numbers are "man-made." Mr. Li, who was head of the Communist Party in northeastern Liaoning province at the time, told then-U.S. Ambassador to China Clark Randt that he looked to more reliable numbers—on bank loans, rail cargo and electricity consumption—to get a fix on the actual growth rate.

Some economists now call these economic indicators the "LKQ Index." That index shows that China's economic growth was a lot weaker than officially claimed in the first half of 2013 and picked up in the third quarter only on a new round of stimulus to meet the annual GDP target of 7.5%.

Pressure to hit the official target has reached new highs as China's Communist Party leaders prepare for a critical Central Committee meeting next month. With a per capita income of about $7,000, China has reached the stage of development when even the previous "miracle economies" of East Asia—Japan, Korea and Taiwan—began to slow, from a GDP growth rate near double digits to around 5% to 6%.

The Central Committee is expected to address key issues facing China in this middle-income phase, including the need to reduce the role of state-owned enterprises, promote fiscal reform and reorient the economy away from an overreliance on exports toward a stronger consumer sector. Though widely praised for the market reforms that got China this far, the Communist leadership seems fixated on a growth target that is no longer realistic for a middle-income country. This obsession will make the next stage of reforms difficult, if not impossible, to achieve.

At the start of this year, there had been signs that Beijing was ready to dial back on the huge new flows of credit and public investment that it unleashed to keep China growing at its target rate after the 2008 global downturn. But that course correction was short-lived. By July, the leadership was ordering up a fresh wave of credit and investment to reach its inflated target.

This approach is not going to produce genuinely sustainable growth. In recent years, China has pumped out new credit faster than any other country, and much of it is going to increasingly shaky investments, not new manufacturing muscle. Five years ago, it took just over a dollar of debt to generate a dollar of economic growth in China, but now it takes four dollars of debt to generate the same growth.

Much of today's lending is going to real-estate speculation and local government vanity projects. Investment is growing at a 20% annual pace this year, much faster than consumption. This is the opposite of what China needs to create a stronger consumer sector and to reform other excesses—including property-market speculation, corruption and pollution—now threatening its old industrial model.

Why did Beijing return to this outdated path? China's leaders may believe they need a GDP growth rate of at least 7% to avoid joblessness and social unrest, but this concern is misplaced. Every percentage point of growth in China's maturing economy now produces 1.6 million to 1.7 million new jobs, up from 1.2 million 10 years ago. So even at a GDP growth rate of 5% to 6%, China would generate enough new jobs for its aging population and maturing economy, which has fewer young people entering the workforce.

China's leaders may also believe they need high growth to ensure that the recent credit binge does not lead to a wave of bankruptcies. But a new wave of low-quality loans only puts millions more borrowers at risk. Loosening credit conditions have pushed up home prices by 17% this year in major cities, raising fears that this latest real-estate boom will end in a burst bubble.

China grew rapidly for three decades by relying on a huge base of low-income workers that no longer exists, and by building the manufacturing export industries that are essential to high productivity growth. This model has reached its limits. Japan and Germany followed a similar path in the postwar years, and their share of global exports eventually hit a peak of 12%—exactly the level at which China has flatlined in the past two years.

The manufacturing share of China's economy is now 30%—the same as Japan at its 1970 peak. Consumption in China is already growing at 7% to 8%, the maximum rate any miracle economy has achieved. If consumption cannot grow faster, and the current rate of investment is dangerously high, then slower GDP growth is unavoidable.

Beijing's devotion to hitting a 7.5% growth target is at the heart of China's problems. That target comes from a rough estimate of the growth rate China needs to double its GDP by the end of this decade. This is a purely political ambition with no basis in economics, reminiscent of the man-made targets that guided the Soviet Union's effort to catch up to the West. The lesson of that failed Communist experiment is that it would have been better to arrive late than never.

Mr. Sharma is head of emerging markets at Morgan Stanley Investment Management and author of "Breakout Nations: In Pursuit of the Next Economic Miracles" (Norton, 2012).

BEIJING—China's leaders agreed to loosen the nation's one-child policy and to give market forces a greater role in the world's No. 2 economy, according to new details of a blueprint for reform released on Friday.

The proposals follow the end on Tuesday of a four-day meeting of top Chinese Communist Party leaders, and they represent the first comprehensive road map for reform under new Chinese President Xi Jinping.

China's One-Child Policy

While a preliminary summary of the meeting released on Tuesday was vague, the more-detailed document released on Friday sketches an ambitious reform program designed to address problems that China faces: maturing growth, rising worries about a wide wealth gap and endemic pollution, and increasingly vocal criticism of Beijing's handling of a number of social issues.

"More attention also needs to be paid to employment, income levels, social security and people's health," the document said.

The test now for Mr. Xi and China's leaders will be how to implement many of its goals, including whether they will be introduced in coming months or will be introduced more gradually. The leadership is likely to face resistance ranging from state enterprises and the bureaucracies that oversee them to local governments, which have been frustrated by attempts at piecemeal reforms in recent years. A special leadership committee to oversee reform, which was announced previously, is supposed to address possible resistance, though the document provides few details on how it will do so.

The document said China would significantly ease its one-child policy, allowing couples to have two children if one of the parents is an only child. Currently, Chinese couples are restricted to one child except under some circumstances, such as rural dwellers, pilot programs in a number of areas and among ethnic minorities.

Enacted in 1980, the policy has been lauded by officials for taming a surging population from a years-earlier baby boom. But economists say it risks eroding China's competitive advantage, draining its labor pool of future workers as the population ages and puts a greater strain on China's emerging social safety net.Related Reading: Third Plenum

The policy has also come under fire for local-level abuses such as forced abortions and sterilizations—practices that are illegal in China but are sometimes used by local officials to meet their family-planning quotas.

On economic matters, Chinese leaders said they would establish a system for insuring bank deposits, prepare a mechanism for financial bankruptcy and ease controls on prices for energy, water, telecommunications and other services. They will also increase the amount of profits that China's vast state-owned enterprises pay to the government.

It also said it would ease curbs on offshore securities investments and mergers and acquisitions, without providing details.

The moves follow calls by economists for Beijing to loosen its grip on capital controls and allow private capital to have a greater role in China's economy. Economists say China's traditional reliance on government investment and exports to fuel its economic growth is unsustainable, and China's leaders have called for a greater role for China's growing consumer class in powering growth.

The document set few firm deadlines. One of them raises the proportion of profits state companies must return to the treasury, increasing that rate to 30% by 2020, from a current range of 5% to 15%.

China also plans to abolish a controversial labor camp system in what Xinhua described as "part of efforts to improve human rights and judicial practices." Under the system, which has been in place since 1957, police are allowed to imprison people in labor camps for up to four years without formal arrest or trial.

Public outrage over the system swelled earlier this year, after a woman named Tang Hui was sent to a labor camp after petitioning authorities for tougher penalties for the men convicted of abducting and raping her daughter. Ostensibly set up to as a way to keep petty crimes from clogging the courts, in practice it is used to imprison petitioners and other politically disruptive people.

Officials had signaled intentions to either reform or abolish the system, known as re-education through labor, as early as January, but this marks the first time the government has mentioned abolishing it in a formal document.

The document stressed resource conservation to combat severe environmental degradation, which has emerged in recent years as a major point of social instability. It added that further liberalization of resource pricing would play an important part in that effort.

Perhaps most notably, the document said in certain parts of China, local governments wouldn't be judged on economic performance alone, and that environmental protection would play an increasingly important role in evaluations. Environmental scholars have long said cadres in China had a disincentive to protect the environment because their promotions were tied too closely to economic growth and other factors.

The government also said it would step up health-care reform, accelerating an overhaul of its public hospital system to create more community hospitals and relieve overrun facilities in big cities.

Authorities will also change the way that doctors are paid to try to address the low wages that have contributed to bribery and corruption in hospitals. It also said catastrophic health insurance would be offered for the first time as part of the health insurance system.

Vladimir Lenin, the founder of the Soviet state and godfather of modern totalitarian politics, once explained the totalitarian worldview this way: "We recognize nothing private." By that criterion, no totalitarian project in our era has been more ambitious than the Chinese government's policy of forcible population control. Since the institution of the so-called One Child Policy in 1980, China's Communist Party has demanded mastery over that final and most intimate of all private spheres, the family.

Forced sterilizations, involuntary abortions, female infanticide and untold other family tragedies have been ruthlessly routine aspects of the national plan to drive down childbearing to meet the state's birth targets. Despite recent news reports trumpeting an official easing of the policy, the changes were inconsequential—and China's demographic future remains dire, not just because of the One Child Policy's ill effects.

What Mao might have termed the "contradictions" of this population-control policy have markedly intensified over the past three decades as China's market-oriented reforms increased autonomy and personal control over other aspects of life. While China today is awash with a general social anger over government corruption and the lawlessness of the nation's rulers, no single state policy is so widely and deeply hated.

Meanwhile, Chinese scholars, demographers and economists have grown increasingly outspoken about what they describe as the irrational and counterproductive consequences of the population policy. Even the government's top think tank, the Development Research Center of the State Council, has publicly issued such criticisms.

The Communist Party's "open letter" that announced the One Child Policy in 1980 also proclaimed: "After 30 years, the currently very intense population growth problem will be eased, and different population policies can be adopted"—a seeming pledge that the program would only be temporary.

All this gave rise to hope that a major change in China's population-control project was imminent—and might be announced by President Xi Jinping at the Nov. 9-12 Third Plenum of the Communist Party's Central Committee. What the regime promulgated, however, was a relatively minor adjustment. Couples would be allowed to have two children if just one spouse is an only child, instead of both spouses as the policy was previously. No time frame was given for the rollout of this adjustment, which reportedly will be introduced in selective "phases" in different regions of the country.

Beijing's population planners expect the revision to have only a limited demographic impact. According to a widely quoted official estimate, about a million extra births a year are expected. In the context of the current 16 million or so annual births, that would amount to a paltry fertility increase of maybe around 6% for China. (No one knows the precise current birth figure, in part because so many parents still try to conceal out-of-quota babies.)

The day after the new birth directives were announced, the Chinese state news agency Xinhua ran the headline "Birth policy changes are no big deal." Beijing did not significantly "reform" population control. Rather, it just reaffirmed its coercive program with one minor and relatively insignificant change.

But why? China today faces staggering demographic problems, including a shrinking pool of working-age men and women and a rapidly aging population that will slow economic growth, perhaps severely. The traditional family structure will be tested by, among other things, a growing army of unmarriageable men, a consequence of rampant sex-selective abortion in the One Child era. To the extent that the policy has "succeeded," it has made each of these demographic problems more acute.

Yet even if Beijing repudiated all forms of population control tomorrow, these problems would persist for the generation to come. Practically everyone who will be in the Chinese workforce in 2030, or the Chinese marriage market in 2035, has already been born under the current restrictions. No variations in population policy today can change this part of the country's future.

The question that should be keeping Communist Party leaders awake at night is: Can Chinese fertility levels recover if and when the controls are abandoned? Alas, the answer to that existential question is not at all clear.

Demographers at the United Nations Population Division (UNPD) and the U.S. Census Bureau calculate that Chinese fertility levels today are far below the level necessary for population replacement. By their reckonings, current childbearing patterns, if continued, would mean each successive generation would shrink by 25% (UNPD) or 27% (Census Bureau). Official Chinese estimates, and the work of some independent Chinese demographers, suggest an even steeper drop.

These fertility estimates are nationwide averages. In China's cities, birthrates are far lower. In Beijing and Shanghai, for instance, official estimates suggest that women are having far fewer than one birth per lifetime (around 0.7 on average). In such settings, scrapping the One Child Policy will make no demographic difference whatsoever: People aren't even using their given birth-quota permits now.

Yet even in rural areas the desire for children may now be more attenuated than is commonly supposed. A major study conducted in 2007-10 by Chinese and American demographers found that the eastern province of Jiangsu only a third of rural families would favor having a second child.

Perhaps this shouldn't be so surprising. In Taiwan and Hong Kong—places that share the greater Chinese culture but have never implemented population-control policies—fertility rates have been fluctuating around one birth per woman for two decades. Levels are only slightly higher in South Korea and Japan.

These more developed East Asian economies have witnessed a "flight from marriage" by growing numbers of young women who choose to postpone or forgo their weddings. The trend now seems to be reaching mainland China, starting as it did elsewhere with the educated urban elite. It would be another factor lowering birthrates no matter what the Chinese government does.

So let us ask once again: Why, apart from its totalitarian impulse, does the Communist Party cling to its abhorrent and manifestly impractical One Child Policy? The most intriguing answer I've heard came from one of China's leading demographers a few years ago. When I asked him this question (couched a bit more politely), he said he could only guess that the leadership in Beijing actually believes that Chinese women will start having five children again if they end the policy.

His guess may or may not be correct. But if his reading of China's leaders is right, or even approximately correct, the Communist rulers in Beijing would be further out of touch with their subjects than almost anyone suspects.

Mr. Eberstadt is a resident scholar at the American Enterprise Institute and a visiting researcher at the Asan Institute in Seoul.

A cash squeeze is rippling through the Chinese financial system despite three days of liquidity injections by the country's central bank, as borrowers scramble to secure funds before the end of the year.

The situation worsened Friday as the interest rate banks charge each other for short-term loans jumped to 8.2%, the highest level since a crippling liquidity shortage in the summer. The stress in the banking system is starting to spread: Stocks in Shanghai fell for a ninth consecutive day to the weakest level in four months, while government bonds dropped, pushing the 10-yield near to its highest level in eight years.

The People's Bank of China issued its second statement about the developments in two days, saying it had injected a total of 300 billion yuan ($49.4 billion) into the financial system over the previous three days.

The statement, released on the central bank's official account on Weibo, China's Twitter-like microblogging service, said the cash injection was aimed at coping with changes in the money market at year-end. It didn't elaborate.

The turmoil has been sparked by a scramble for funds by banks and other borrowers in the world's second-largest economy as they near the end of the year, when they typically need extra cash to meet regulatory requirements and funding demands from companies.

This year many of China's banks are already under stress. Investors have pushed their stock prices below book value because of concerns about rising defaults on loans and the slowest domestic economic growth in 20 years.

China's demand for natural gas is expected to increase dramatically over the next decade -- perhaps rivaling Russia as second only to the United States. China's differences from places like South Korea and Japan, such as its domestic production potential and access to pipelines from the former Soviet Union, will limit Chinese demand for liquefied natural gas, but that demand will grow nonetheless. Thus, China and other Asian countries will continue working together to find ways to drive down liquefied natural gas prices in Asia. In the longer term, the natural gas distribution and consumption infrastructure built up over the next decade could be used to metabolize the country's massive shale gas deposits once China masters the technology to extract them, thus massively shifting Beijing's energy security away from foreign sources. Analysis

China's natural gas sector is in the midst of a transition that could alter Asian natural gas markets for better or for worse, depending largely on how much the country's demand increases and how much shale gas it produces. Beijing knows that it must move away from using coal for almost all of its energy needs, as the environmental costs have begun to offset the strategic and economic benefits. Natural gas is an integral component of solving this problem, but how much demand this will amount to -- and where the supplies will come from -- is an important issue, particularly for other Asian countries that must import large volumes of liquefied natural gas. Even if China shifts just a small percentage of its energy mix from coal to natural gas, this would mean a gigantic change in the volume of natural gas demand because of the amount of energy China consumes.

China's vast resources of coal have underpinned the country's unprecedented growth the last four decades. Historically, China's domestic coal supplies have also been relatively cheap. This, coupled with the sheer size of its coal resources, has led China to use coal in large volumes not only in traditional coal sectors, such as power generation, but also in numerous unconventional ways.

While using coal for power plants obviously offsets some natural gas demand, China's atypical applications of coal also tend to push down the demand for other energy sources used for energy consumption or transformed into non-energy products. For instance, methanol derived from coal now represents nearly 10 percent of China's transportation fuel pool -- and the country is contemplating adopting a requirement that gasoline contain 15 percent methanol (some provinces already have similar regulations). Additionally, most of the world's production of nitrogen-based fertilizers uses natural gas as a feedstock, whereas China typically uses coal.

For China, coal's low cost is only one part of the rationale behind its heavy use. China ceased being an exporter of oil in the early 1990s and is now the world's largest oil importer. China had never been a relatively significant consumer or producer of natural gas until the late 2000s, but today it imports roughly a third of its natural gas. Not wanting to outsource its energy security to international markets, China prioritized using coal over natural gas.

However, there was a marked shift in China's energy strategy, particularly for natural gas, beginning around 2005 that has accelerated in the last three years. China's natural gas demand has exploded. Although Chinese demand for oil and coal also grew during that period, its astronomical growth predated the surge in natural gas demand, which doubled between 2007 and 2012. Clearly, something had changed. This was first reflected in China's 12th Five-Year Plan, which outlined a shift toward natural gas as part of more environmentally friendly initiatives.

The shift is due to a number of factors, but there are three main drivers. First, in the past five years coal has become the focus of growing public anger regarding China's deteriorating environmental conditions. Beijing has begun viewing continued coal emissions, especially in wealthier coastal urban areas, as a potential risk to social and political stability, one of China's geopolitical imperatives. As a response, some cities, such as Beijing, are switching from coal-fired power plants to natural gas-fired power plants, which give off fewer emissions. Second, China's quality of life is gradually increasing, and domestic consumption of natural gas -- either for cooking or heating -- is on the rise. Finally, China has realized that it possesses massive natural gas resources in the form of shale gas -- which means that China's natural gas security could be realized eventually, even if in the interim China must rely heavily on imports.Estimating China's Potential Natural Gas Demand

China's potential demand is staggering, though estimates of it vary considerably. Officially, the State Council of China anticipates that demand could increase from 2012's level of about 150 billion cubic meters to 200 billion to 250 billion cubic meters by 2020. The 12th Five-Year Plan has it reaching 230 billion cubic meters by 2015 alone. The Ministry of Land and Resources has said it could be 350 billion to 380 billion cubic meters by 2020 and 550 billion to 600 billion cubic meters by 2030. UBS has estimated it could be as much as 400 billion cubic meters by 2020, and Barclays has estimated that demand could reach 450 billion cubic meters by 2020. To put these numbers in perspective, if China's demand increases to 400 billion cubic meters, the increase would be larger than the entire current Asia-Pacific liquefied natural gas market. Thus, other Asian liquefied natural gas consumers are looking at China quite nervously.

Of course, the liquefied natural gas market will not satisfy all of China's demand. China has been securing supplies from Central Asia and Russia through pipelines. China has signed a deal to import 40 billion cubic meters from Turkmenistan that could increase to 65 billion cubic meters by 2020. In September, China signed a deal with Russia for another 60 billion cubic meters, although the deal has not been finalized due to disputes over pricing. (China also has a smaller deal with Myanmar.)

Outside of China's domestic shale resources, Beijing is targeting 80 billion cubic meters of tight gas production and 30 billion cubic meters of coal regasification, and China National Offshore Oil Corp. is hoping to push further offshore for natural gas production. Collectively, these other unconventional sources coupled with conventional natural gas could reach 150 billion to 160 billion cubic meters, up from the 2012 level of 110 billion cubic meters. However, several of its supply deals with Russia and Central Asian countries will not come to fruition until as late as 2020. This means that in the interim there could be a larger reliance on liquefied natural gas, but after 2020 this demand could subside as volumes of shale and piped gas begin to increase.

Thus, sources other than shale and liquefied natural gas imports could supply about 250 billion cubic meters or a bit more, which would only satisfy the most conservative estimates for the growth in China's natural gas demand. While more piped natural gas deals could be signed, those plans likely would not be completed until well after 2020, leaving shale and liquefied natural gas to make up the difference. Chinese Shale BasinsClick to EnlargeShale Production's Effect on Liquefied Natural Gas Demand

China's potential in shale gas production is nearly as staggering as its potential growth in demand. The U.S. Energy Information Administration estimates that China possesses by far the world's largest reserves of technically recoverable shale gas. Although China's shale gas industry is not as advanced as the United States', it could be the most advanced outside of North America.

China's target is to produce 60 billion to 100 billion cubic meters of shale gas by 2020, but there are severe limitations to hitting the target. China is more likely to produce somewhere around 25 billion cubic meters of shale gas by then. In the longer term, as Chinese oil and gas companies master shale gas extraction techniques, production will reach loftier goals. However, this process is likely to take two decades, not one.

This means that China will realistically be able to access 275 billion cubic meters to perhaps 300 billion cubic meters of natural gas from land-based (both piped and domestic) sources by 2020. It remains unclear as to whether or not this will be able to satisfy most of China's demand. Should China's demand reach higher estimates, such as Barclay's 450 billion cubic meters by 2020 or the Chinese Ministry of Land and Resources' 380 billion cubic meters, China could be forced to import as much as 150 billion cubic meters of liquefied natural gas by 2020.

That kind of demand could very easily overwhelm liquefied natural gas markets internationally, ensuring that liquefied natural gas supply diversification will not lead to lower prices. However, this is unlikely, because there will remain an intrinsic link between China's domestic supply and domestic demand. While China has been pushing for natural gas to offset coal and oil, Beijing still must critically balance two competing needs: the need for natural gas to replace those other sources and the strategic risks of overreliance on foreign sources of natural gas (as opposed to coal, which it can largely produce domestically). As a result, China's overall demand for imported natural gas -- including liquefied natural gas -- will be related to the success and pace of its shale gas development.

Additionally, the most likely scenario in which China's liquefied natural gas demand would increase dramatically is one in which liquefied natural gas prices do not skyrocket but are low enough that it would be worth importing large volumes of natural gas despite the strategic losses. Either way, China would still be importing small volumes of liquefied natural gas and has every interest in working with Japan, South Korea and other liquefied natural gas importers in order to manage prices. However, China's potential demand spikes leave those other liquefied natural gas importers worried -- especially those, such as Japan, that have few options other than importing liquefied natural gas.

In China's latest show trial, a Beijing court on Sunday sentenced New Citizens Movement leader Xu Zhiyong to four years in prison for "disturbing public order" via peaceful protests over official corruption and public access to education. His real crime was to be a brave, patriotic and measured critic of the Chinese government's abuses and hypocrisies—as demonstrated again in the closing statement he tried to read at trial last week.

Addressing the judge and prosecutors—who barred members of the press or public from attending the one-day proceeding— Mr. Xu said that his ordeal "is actually an issue of fears you all carry within: fear of a public trial, fear of a citizen's freedom to observe a trial, fear of my name appearing online, and fear of the free society nearly upon us."

"What the New Citizens Movement advocates," he said, "is for each and every Chinese national to act and behave as a citizen, to accept our roles as citizens and masters of our country—and not to act as feudal subjects, remain complacent, accept mob rule or a position as an underclass. To take seriously the rights which come with citizenship, those written into the Universal Declaration of Human Rights and China's Constitution: to treat these sacred rights—to vote, to freedom of speech and religion—as more than an everlasting IOU."

According to Mr. Xu's lawyer, the judge silenced the 40-year-old activist after 10 minutes, calling his words "irrelevant." But the lawyer, Zhang Qingfang, was able to circulate Mr. Xu's prepared text to journalists before being detained on Sunday himself.Enlarge Image

Chinese rights advocate Xu Zhiyong Reuters

"Our mission is not to gain power but to restrict power," Mr. Xu planned to tell the court. One of his movement's priorities was pushing Chinese leaders to disclose their financial assets to the public. "More than 137 countries and territories around the world currently have systems in place for officials to declare assets, so why can't China?" his statement asks. "What exactly is it these 'public servants' fear so much?" On the very day of his trial, the U.S.-based International Consortium of Investigative Journalists released a report detailing offshore bank accounts held by relatives of Chinese President Xi Jinping, former Premier Wen Jiabao, former Party supremo Deng Xiaoping and dozens of others.

At trial Mr. Xu also planned to tell his persecutors that "under true democracy and rule of law," China would have free and fair multiparty elections, an independent judiciary, a military that answers to the people (not to one political party), free speech and freedom of belief. "These modern democratic values and measurements are rooted in common humanity. They should not be Eastern or Western, socialist or capitalist, but universal to all human societies."

Facing trial two days after the birth of his first child, Mr. Xu stated: "Some people have to make sacrifices, and I for one am willing to pay any and all price for my belief in freedom, justice, love, and for a better future of China." Such is the heroic thinking of China's dissidents—figures like Nobel Peace laureate Liu Xiaobo, detained Uighur scholar Ilham Tohti and longtime activist Hu Jia, who was summoned again by Beijing police on Sunday afternoon. Their names should be on the lips of diplomats and citizens world-wide.